What is Tether ($USDT) and Why Its Downfall Could Collapse the Crypto Market

What is Tether ($USDT) and Why Its Downfall Could Collapse the Crypto Market

Cryptocurrency | 11 minutes to read | 06.19.2022
TL;DR Tether ($USDT) is a stablecoin that was created to be a digital U.S. dollar and to always be tradable as 1 USDT for $1. When users trade U.S. dollar to Tether, it mints new coins and keeps the dollars as a reserve. When a user sells USDT, Tether burns the coins and gives dollars from the reserve. The main idea behind Tether is to protect users from volatility and to make trading cryptocurrencies easier. Tether claims that it has a 1:1 backing to cover all the USDT tokens in circulation. This backing is a combination of cash, loans, and investments. If it comes out that Tether cannot back its currency 1:1, then there could be a possible bank run on Tether, leaving some people with a worthless token. Other critics are afraid that Tether has basically just been printing tokens that are not backed by anything, which could be inflating the price of larger cryptocurrencies like Bitcoin and Ethereum. There are other stablecoins that have recently been eating at Tether's market share. The most popular, USD Coin, is audited by an accounting firm to make sure the reserves are there to cover the amount of USDC tokens.
Imagine being able to send United States dollars to someone instantly without having to use any third party. That’s the goal of Tether. Tether was created in 2014 by a Hong Kong based company called Tether. It is owned by iFinex Inc, who also owns the crypto exchange BitFinex. Tether is the most traded cryptocurrency and has by far the largest trading volume making it one of the most important cryptocurrencies. Massive amounts of money are moved in the crypto market using Tether. But if Tether fails it could cause a massive collapse of the crypto market. It will be like the meteor that hit the dinosaurs, except that instead of making dinosaurs extinct it makes your investment extinct. Let’s learn all about Tether.

What is Tether?

Tether ₮ ($USDT) is a stablecoin created to be a digital dollar that can be sent to users using the blockchain without a third party. A stablecoin is a token that's meant to be traded one for one of a certain currency. In Tether's case it is mainly the United States dollar. 1 USDT = $1. Tether does have stablecoins for the Euro, the Chinese yuan, and gold, but these are not quite as used as the U.S. dollar. Now you have a digital dollar that you can send to anyone. Tether doesn’t have its own blockchain. Instead, it is built as a second layer token on blockchains like Bitcoin, Ethereum, EOS, Tron, and Algorand. Tether has the third highest market cap in cryptocurrency and it has a circulating supply of 70,038,816,029 USDT. There is no max supply.

How does Tether work?

The goal of Tether is to always maintain the one to one peg with the United States dollar. It remains stable by keeping reserves. When a user deposits US dollars into Tether’s reserve, Tether then mints a number of USDT tokens depending on the amount deposited, and gives them to the user. If someone sells USDT back to Tether, they will pull an equal amount of fiat money out of their reserves, give it to the user, and then burn the tokens. For example, a user can use $100 to buy 100 USDT, and there is 1$ for every 1 USDT in circulation. If that user sells 25 USDT and receives $25 then Tether now has $75 in reserves and 75 remaining tokens in circulation. Using this method it can keep the price of its cryptocurrency stable because they can always replace the tokens with actual dollars.

Why is Tether Useful?

The stablecoins main purpose is to make trading crypto easier. Instead of buying other crypto with cash, you can buy Tether for cash instead, and use that purchase crypto.

Protects From Volatility

The most useful thing that Tether does is protect crypto users from volatility, which is when the price fluctuates wildly over a period of time. For example, just in the past month Bitcoin has had a high of $32,000 and a low of $18,000 and every possible price in between. While Tether has always been $1 per coin. That means that Tether can buy almost double the amount of Bitcoin now than a month ago. Most crypto are speculative assets, so some traders like to take their money out of volatile cryptos during bear markets and keep it in USDT while they wait for a time to buy back.

Used to Swap Crypto

Tether can also be used to swap cryptocurrencies easily. Usually you cannot trade Bitcoin for Ethereum without a bridge application built on a blockchain like Polkadot. With Tether, you can exchange your Bitcoin for USDT and then use that to buy Ethereum. You can do that with any crypto that can’t easily be exchanged for each other.

What is Tether Backed By?

Remember, Tether works by issuing a new coin whenever it receives $1. That $1 is put away safely until someone wants to trade a USDT for it. That way there should always be one dollar for every one USDT in circulation. Tether claims it is backed by bonds and cash reserves. In June 2022, Tether claimed, on its own website, that it is backed by about 85.64% cash, cash equivalents, short term deposits, and commercial paper. About 6.02% of Tether’s backing is in investments like digital tokens, though they don’t say which tokens. 4.52% is backed by corporate bonds and precious metals, like gold. And the final 3.82% is backed by secured loans. Tether further breaks down its main 85% backing like this: 55.53% in U.S. Treasury bills (dollars bought at a discount to be traded for face value at a later date), 28.47% in commercial paper (money issued to help pay short term debts), 9.63% in money market funds (an easily liquidated, low risk investment), 5.81% cash and bank deposits (actual money), 0.41% in non-U.S. Treasury bills, and 0.15% in reverse repurchase agreements (an agreement to borrow securities in order to sell them back at a slightly higher price after a short amount of time.) Tether has never been audited by a third party, which means that its claims that it is backed one for one are questionable. The parent company of Tether also owns a crypto exchange, BitFinex, which was hacked for a large chunk of crypto. Due to loaning $700 million to the hacked exchange, Tether was briefly not backed one to one and because of that was then fined by New York state for the amount of $18.5 million, and had to stop trading with any residents, which is another crypto downside to New York state. BitFinex eventually did repay Tether’s loan. BitFinex was dealing with controversy of its own when, after the hack, slashed the crypto holdings of users who were not affected by the hack. Instead, it gave them the exchange’s own coin. In late 2021, Tether was again fined, this time for $41 million, by the U.S. Commodity Futures Trading Commission (CFTC) for claiming that it was fully backed by U.S. dollars. The CFTC claimed that Tether only had enough fiat money in its reserves to back 27.6% of USDT tokens. So, you can see Tether has its fair share of critics wondering if it is really backed like it says it is.
Tether logo

Why Could Tether Collapse the Crypto Market?

Tether’s USDT is the crypto with the most trading volume every day. In the last 7 days, Tether has traded an average of $68 billion per day. We can compare this to Bitcoin, the crypto with the highest market cap, over the same days and see that it has done about $41 billion in trading volume per day. Ethereum had about $27 billion traded per those same 7 days. It has had multiple 100 billion dollar trading days, and it's said that Tether is responsible for about 67% of Bitcoin trades around the world. If Tether is not backed one for one it is possible that there could be a bank run on USDT. If investors know that Tether can’t repay everyone back they will quickly start to dump their holdings, causing a panicked, mass sell off, and possibly causing the price to depeg from the United States dollar. Tether would have to start dipping into its reserves to pay these users. It would have to start cashing in its investments, possibly losing money on them. Unless Tether really does have over 70 billion dollars in reserve, there won’t be enough actual fiat money to go around to the holders if everyone decides to try and sell at the same time, and some people will end up with a crypto token that no longer maintains its $1 value. Essentially, USDT would be worthless. Since a huge portion of the crypto industry relies on Tether to keep prices stable, a collapse of Tether could mean that the industry as a whole would take a massive beating. Exchanges could go under and lose their user’s money. It is important that Tether actually does have backing reserves to cover all of its tokens. Otherwise they could just print as many tokens as they wanted to and claim they are all backed, while essentially just creating money out of thin air. They can then exchange those tokens, apparently worth $1, for another crypto, like Bitcoin. If Tether can just print coins, it means that a good chunk of the crypto market is inflated by USDT, and therefore the market caps of certain cryptocurrencies are larger than they should be. Especially when a 6% chunk of their reserves are being invested into other digital tokens, most likely Bitcoin or Ethereum, and Tether would have to dump these, possibly for a loss, in order to help repay users for exchanging their USDT. 6% of $70 billion is about $4.2 billion. That would cause a pretty big price drop in these tokens, further panicking investors of those tokens and causing them to possibly sell even more, shooting the price further downward. There could potentially be a bank run on a lot of other cryptocurrencies as well. All of this is a recipe for the crypto market to crash hard, causing prices to spiral downward, and could give the public a reason to stop trusting cryptocurrency altogether.

Other Popular Stablecoins

Tether isn’t the only popular stablecoin, it’s just the most popular. Let’s take a quick look at some of the other coins, and see how they compare to USDT.

USD Coin ($USDC)

USD Coin is the 4th largest cryptocurrency by market cap, coming in right behind Tether. Like Tether, USDC is pegged 1:1 to the United States dollar. USD Coin doesn’t have nearly as much trading volume as Tether, but still handles multiple billions of dollars worth of trades every day, and has more than doubled its market cap in the past year (2021) despite the market crashing in 2022. The difference between Tether and USDC is that USD Coin has a major accounting firm keeping the claims about their reserves in check. They are making sure that USDC has the funds they claim they do in order to match the number of coins in circulation. USDC is being seen as the safer bet, since they are actually being held to what they claim, and has yet to be accused or fined for any wrongdoing. Proving its backing has been great for USDC because it has taken over a significant chunk of the stablecoin market. In February 2021, Tether controlled about 76% percent of the stablecoin market, while USD Coin held on to about 16%. Fast forward one year and Tether now holds only 45% percent of the market, and USDC now claims 30%. Each day those two numbers get closer together.

Dai ($DAI)

Dai is a bit smaller than the other two with the 12th largest market cap. Again, this coin is pegged one for one with the U.S. dollar, but this stablecoin is an Ethereum token. Dai’s trading volume is usually less than a billion dollars per day, but on occasion has had some billion dollar trading days. Dai was created by a DAO, decentralized autonomous organization, called MakerDAO. A DAO is a company that is run in a decentralized manner using smart contracts, instead of a centralized body, like Tether. The way Dai remains stable is that it only mints new tokens when other cryptocurrencies, like ETH, LINK, or MATIC, are deposited into smart contract vaults. These cryptos are then used as collateral, allowing users to borrow Dai against them. Since DAI is an Ethereum token all transactions, including the burning and minting of DAI, are publicly available for anyone to see. The entire system is transparent and can easily be audited by anyone.

Terra ($UST)

UST was an algorithmic stablecoin, which means that it’s backed by another crypto. In Terra’s case it was a sister crypto called LUNA. UST was the stablecoin used for everyday transactions, and LUNA was the store of value that you invested in. The appeal of putting your money into UST was a 20% return in “interest” for holding the coin. You were then supposed to be able to trade 1 UST for $1 worth of LUNA, through an algorithm that was supposed to keep UST stable. Long story short UST depegged from a dollar, which caused LUNA to create more and more coins, causing hyperinflation, and driving the price of the coin to near worthlessness. You can read a more detailed article about how Terra and Luna collapsed. Summary Tether ($USDT) is a stablecoin that’s meant to be pegged one for one with the United States Dollar. Tether maintains its peg by issuing new tokens when it receives U.S. dollars, and burning tokens when it trades U.S. dollars for USDT. Tether is important for protecting crypto users from volatility, and is used to exchange many cryptocurrencies with each other. Tether claims that it is backed one for one by its reserves, which consists of a combination of cash, digital investments, secured loans, corporate bonds, and precious metals. If Tether is not honest about the claim of their reserves, there could be a bank run on USDT, which could collapse the entire crypto market, due to a massive sell off of cryptocurrencies that rely on Tether to facilitate trades. However, Tether isn’t the only stablecoin. There are others like USD Coin, a stablecoin that is audited to show they have the reserves they claim, or Dai, a decentralized stablecoin that uses Ethereum tokens as collateral. Now that you know all about Tether, learn how to use simple math to calculate the price of cryptocurrency.
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