How Do Off-Chain Reserve Assets Introduce Counterparty Risk to an On-Chain Stablecoin?

Off-chain reserve assets (like fiat currency, Treasury bills, or commercial paper) introduce counterparty risk because they rely on a third-party custodian (e.g. a bank or trust company) to hold and manage them. The on-chain stablecoin holder is now exposed to the risk of the custodian's insolvency, fraud, or regulatory seizure.

This breaks the trustless nature of the blockchain, as the digital asset's value is tied to the reliability of an external, traditional financial institution.