TRADE.BTC is backed by BTC held in a combination of  hot, cool, and cold storage.    It is fundamentally no different than BTC held in other exchanges *EXCEPT* that rather than controlling your exchange account with a username and password you control it with your BitShares account.

Blocktrades is run by people who have commit access to the BitShares repositories.

I think I understand this is done thru the gateway, but doesn't this assume that the gateway has a balance enough to withdraw, and thus having similar liquidity risks as with a centralized exchange but with the security of being able to cash out from any gateway that is liquid for the required amount? Does the gateway specify a fee for conversion (trade.btc => btc)?

You are correct.  If Blocktrades had their issuer key compromised any BTS on order books would be at risk.

I have advised them to pre-issue a fixed amount and then keep the issuer account in cold storage with multi-factor authentication.  This would keep the issuer account secure. 

If they were compromised they would have halt trading of their asset on the blockchain.

I like it.