- Tether is a “stable coin” designed to mirror the price of one dollar
- 20% of all cryptocurrency trades use tether as a proxy for the dollar.
- Tether claims its coins are 100% backed by real US dollar reserves, but this has never been independently proven.
- Tether is linked to controversy over close links to the Bitfinex exchange and market manipulation.
Tether is wreaking havoc on the markets this week as traders move money out of the stable coin and into other cryptocurrencies.
Tether (USDT) is known as a “stablecoin” as its value is pegged to the price of a dollar.
When it was first introduced, it brought a degree of stability to the volatile cryptocurrency market. It allowed investors to easily trade bitcoin against the dollar and was even used by Taiwanese banks to execute international transfers.
But this week tether slipped off its “peg,” falling as low as $0.85 on the Kraken exchange.
It was triggered by claims that tether is not fully backed by real dollars. To add fuel to the fire, tether is closely linked to Bitfinex – a cryptocurrency exchange rumored to be on thin ice financially.
All this combined on Monday, resulting in a mass exodus from tether.
But what is tether, exactly? How does it work? Why do cryptocurrency traders use it, and why is it so controversial?
What is Tether?
Tether first emerged in 2015. It’s a coin designed to bring stability to a volatile cryptocurrency market.
The price of tether is pegged to the US dollar so, theoretically, one tether token should always be the same as a dollar.
In reality, the price of tether fluctuates against the dollar slightly. Generally speaking, however, it’s as stable as cryptocurrency gets.
There are currently 2.3 billion tether tokens in circulation.
According to Tether, each token is 100% backed by a real US dollar in a reserve bank.
“Every tether is always backed 1-to-1, by traditional currency held in our reserves. So 1 USD₮ is always equivalent to 1 USD.”
This claim, however, is a huge source of controversy (we’ll get into that shortly).
How is Tether Used?
According to Bloomberg, tether is used in 20% of all cryptocurrency trades. And as you can see in the chart below, tether is the second-most traded cryptocurrency by volume, according to CoinMarketCap.
There are many good reasons for this:
1. Easily trade against the dollar
Because tether mirrors the price of a dollar, we can use it to trade against bitcoin and ethereum as it moves against the dollar without actually using fiat currency itself. It’s faster and more efficient.
2. Keep money on the sidelines
Traders often keep their money in tether while waiting for the perfect moment to enter a position or investment.
In the ongoing bear market, for example, traders can keep their money stable in tether while the rest of the cryptocurrency market declines.
Why don’t they just withdraw their money to real dollars? Well, some cryptocurrency exchanges don’t even support dollars. And by the time traders have moved their dollars onto an exchange, they may have missed an opportunity.
By keeping money in tether, they can execute a trade quickly.
3. Exchanges don’t always support dollars
Many cryptocurrency exchanges don’t support dollars. On Binance, the world’s largest crypto-crypto exchange, for example, you can’t deposit, withdraw, or trade fiat dollars.
Supporting fiat currency means complying to complex regulation and setting up bank partnerships. Some exchanges don’t have the means or inclination to do this.
Instead, they rely on tether to provide dollar liquidity. Tether is simply used as a proxy for the real dollar.
Who Created Tether?
Tether’s CEO is Jan Ludovicus van der Velde. He’s also the CEO of Bitfinex, a controversial Hong Kong cryptocurrency exchange.
Both tether and Bitfinex also share a chief strategy officer, Phillip Potter.
This close relationship with Bitfinex has fueled rampant speculation about tether and its legitimacy.
Is Tether Really Backed by $2 Billion Dollar Reserves?
The speculation ultimately comes down to this question: is every tether token backed by a real dollar?
Tether certainly claims so. Its website says every tether is 100% backed.
Tether’s white paper also promised that:
“Professional auditors will regularly verify, sign, and publish our underlying bank balance and financial transfer statement.”
However, no independent audit has ever been able to prove the underlying funds.
A report by researchers at Texas University concluded that tether backing is “incomplete.” In other words, there aren’t enough real dollars to back every tether.
Tether has always disputed this claim. They even hired a law firm to provide documentation. Freeh, Sporkin & Sullivan LLP (FSS) produced a report that concluded that Tether’s two banks held $2,545,067,236 USD. That’s enough to cover the tether tokens.
It’s worth pointing out, however, that FSS later confirmed this was not an official audit.
Why Does it Matter?
If tether doesn’t have a fully backed dollar reserve, there’s a risk of cryptocurrency “bank run.”
To explain, let’s start with your normal bank account for a moment.
Let’s say you’ve got $1,000 in your account. Your bank doesn’t actually have that $1,000 cash sitting in a vault.
The bank only keeps a small amount in reserve for people to withdraw (the rest is loaned out or invested in other assets).
This is called “fractional reserve” banking. Banks only need a “fraction” of the total reserves on hand.
Usually, that’s not a problem because most people have savings accounts they don’t touch very often. No-one needs all their money at one moment.
But let’s say there’s an economic crisis. Everyone might flood to the banks to get their money out. If there’s not enough money in the bank for everyone to withdraw, it’s called a “bank run.”
The same thing could happen to tether.
If everyone holding tether simultaneously decides to sell their tokens, tether needs to be able to give them back their dollar equivalent.
And if tether doesn’t have those dollars available in reserve, it could crash the system.
Controversy Around Tether and Bitfinex
This week’s controversy around tether isn’t new.
Tether has been accused of market manipulation in the past. One research paper earlier this year claimed that tether manipulation was responsible for bitcoin’s phenomenal all-time-highs in December 2017.
In simple terms, the researchers claim that Bitfinex (which we know is closely linked to tether) was creating tether tokens out of thin air when traders bought USDT.
These “magic” tethers were then used to purchase bitcoin – artificially inflating the price.
Of course, if this is true, those tether tokens were not backed by real dollar reserves.
Tether is a fantastically useful cryptocurrency. It brings an element of stability to the cryptocurrency market and provides an easy way to trade against the dollar.
However, tether and the team behind it are unable to shake the claims of controversy. Until tether releases a full independent audit, critics will continue to question their dollar backing.
Similar stable coins like the Gemini dollar and Paxos Standard gain momentum every time tether stumbles. For now, however, tether remains the largest stable coin by far, and the eighth largest cryptocurrency by market cap.
Learned something new in this article? Subscribe to the Block Explorer newsletter.