Fiat-Backed vs Crypto-Backed: KYC/AML Requirements

Mandatory KYC/AML for on/off-ramps: Centralized issuers like Circle and Tether require full identity verification on their platforms (e.g., Coinbase, Kraken). This is non-negotiable for converting to/from USD.

Pros:

• Regulatory Clarity: Clear path for institutional adoption and banking relationships.
• Audited Reserves: Monthly attestations (e.g., Grant Thornton for USDC) provide transparency.

Cons:

• User Friction: Adds significant steps to the user journey, hurting conversion.
• Geographic Restrictions: Blocked in sanctioned regions or where issuer lacks licenses.

No issuer-level KYC for minting/redeeming: Protocols like MakerDAO and Liquity are permissionless. Users interact directly with smart contracts using only a wallet.

Pros:

• Global, Permissionless Access: Users from any jurisdiction can mint stablecoins by collateralizing crypto assets.
• Censorship-Resistant: No central entity can block a wallet from using the core protocol.

Cons:

• Off-Ramp Complexity: Converting to fiat still requires an exchange, which will enforce its own KYC.
• Protocol Risk: Relies on the security and governance of the underlying DeFi system (e.g., Maker MKR holders).

Your primary use case is regulated finance or institutional on/off-ramps.

• You are building a compliant CeDeFi platform that needs to interface directly with traditional banks.
• Your users expect 1:1 redeemability with USD via a known, licensed entity.
• Your legal team requires working with entities that have FinCEN MSBs and state licenses.

Your product prioritizes decentralization, global access, or composability within DeFi.

• You are building a permissionless DeFi protocol where users must interact without sign-up.
• Your user base is globally distributed, including in underbanked or high-inflation regions.
• Your stack requires deep, trustless composability (e.g., using DAI as collateral in other protocols like Aave or Compound without intermediary approval).

Regulatory Clarity: Issuers like Circle (USDC) and Tether (USDT) are licensed entities with established banking and compliance programs. This matters for institutional adoption and integration with TradFi rails.

Simplified Audits: Reserve attestations (e.g., monthly reports from Grant Thornton for USDC) are standardized. This provides transparency for treasury managers and corporate treasuries requiring verifiable asset backing.

Mandatory KYC/AML: All on-ramps and off-ramps require identity verification. Users can be blacklisted (e.g., OFAC-sanctioned addresses frozen). This creates friction for permissionless DeFi and global user bases in restrictive regions.

Centralized Control Point: The issuer is a single point of failure for compliance actions. This introduces counterparty risk and censorship risk, as seen with Tornado Cash-related address freezes.

Permissionless Minting/Redeeming: Users generate DAI by locking ETH, stETH, or other whitelisted crypto assets in vaults via smart contracts. No identity checks are required at the protocol level. This is critical for decentralized ethos and uncensorable finance.

Reduced Regulatory Surface: The protocol itself doesn't hold fiat or manage user identities. Compliance burden shifts to front-end interfaces (e.g., Oasis.app) and off-ramp providers, insulating the core system.

Indirect KYC Exposure: While minting is permissionless, converting DAI to USD often requires a centralized exchange with KYC. Real-world asset (RWA) collateral (e.g., Maker's ~$2B in US Treasury bills) reintroduces traditional compliance through the asset originator.

Complexity & Volatility Risk: Users must manage collateralization ratios and liquidation risks. This is unsuitable for non-technical users seeking a simple dollar peg, as it requires active debt management versus a simple fiat swap.