Stablecoins are one of the most popular tools in crypto. Unlike Bitcoin or Ethereum, the only coins that are more valuable by market cap, these digital tokens aren’t meant to be speculative assets. Nor are they expected to swing wildly in value.
Instead, stablecoins are designed to support the establishment of decentralized finance, or DeFi, a crypto-based industry replicating traditional financial activities such as trading, lending, and earning interest on deposits.
Stablecoins are pegged to traditional, or fiat, currencies such as the U.S. dollar or the euro. As a result, stablecoins are intended to be a reliable medium of exchange that’s insulated from the volatility that often roils the crypto market.
What is Tether?
Tether crypto is the No. 1 stablecoin in terms of market capitalization, which is the value investors place on tradable assets. For years, it has been the No. 3 cryptocurrency, ranking just behind Bitcoin and Ethereum, and is worth tens of billions of dollars. Tether’s USDT coin is pegged to the U.S. dollar, and one token is supposed to constantly equal one greenback.
A precursor to Tether’s stablecoin was introduced in 2014 by co-founders Reeve Collins, Craig Sellers, and Brock Pierce, a former child actor and crypto entrepreneur. Tether is controlled by a Hong Kong-based company called iFinex Inc., which also runs Bitfinex, one of the biggest exchanges for Bitcoin in the world.
Tether was set up to make it easier for investors to transfer so-called fiat currencies—money managed by central banks such as the U.S. Federal Reserve—onto blockchains. Blockchains are online digital ledgers that support and mint cryptocurrencies, while also serving as the official record of all crypto transactions.
In a sense, stablecoins function like a border station between DeFi and TradFi, or traditional finance. Investors who want to enter the crypto market with a position of equal value can do so by converting their dollars into USDT. Conversely, investors who want to sell their cryptocurrencies but not leave the market can park their holdings in USDT instead of cashing out for dollars.
How does Tether work?
To use Tether, customers have a couple of options. They can buy the stablecoin directly from Tether by opening an account with the company via its website. That entails submitting to a know-your-customer review by the company, a process that establishes the customer’s identity and legitimacy. Next, a customer deposits U.S. dollars or another currency into an account at Tether. In addition to the dollar, the company exchanges USDT for the British pound, the euro, the Mexican peso, gold, and yuan traded outside mainland China.
In return, Tether sends USDT coins to the customer’s crypto wallet and they can be exchanged or traded for services or other tokens in the crypto market. Tether tokens can be used on several blockchain networks, including Bitcoin, Ethereum, Solana, Algorand, and Tron.
Customers may redeem their USDT by transferring them from a crypto wallet back into their Tether account. Tether then removes the tokens from circulation and pays the customer back in fiat currency. There are more than 66 billion USDT tokens in circulation.
How is Tether supported?
Tether claims its USDT coin is fully backed by a reserve fund composed of U.S. dollars, corporate bonds, precious metals, secured loans, and other investments, including digital tokens.
According to Tether’s latest “assurance opinion” at the end of the first quarter in 2022, almost 86% of the reserve was in cash and cash equivalents, including commercial paper, which are short-term corporate loans. At that time, according to an external audit of the company, this portion of the reserve would have been worth $70.6 billion.
How does Tether make money?
Investors who choose to buy USDT directly from Tether must pay a one time $150 “verification fee” to open an account, and a commission of 0.1% per deposit of fiat currency, or $1 for every $1,000. The company doesn’t charge customers to deposit or withdraw USDT from their accounts. Yet, it does require a minimum deposit of $100,000 in fiat currency. This requirement limits the direct purchase of Tether primarily to professional investors. Ordinary investors may bypass these costs by going through cryptocurrency exchanges such as Coinbase or Kraken.
What are the risks of using USDT?
The greatest risk confronting holders of USDT is clear—if the stablecoin slips from its peg and loses value against the dollar or another reserve currency, it will lose credibility and may collapse as holders rush for the exits.
This is what happened in May 2022, when another stablecoin ostensibly backed by the dollar called TerraUSD plunged in value, wiping out investors and leading to the $60 billion collapse of the Terra network. Terra was somewhat different from Tether: It was what’s known as an algorithmic stablecoin, which means it wasn’t backed by a reserve of actual dollars or other assets but rather by a computer algorithm that simulated a reserve.
The fallout from the Terra fiasco was so fierce that USDT briefly slipped to 95 cents on the dollar in May as Tether was hit with $10 billion in redemptions. U.S. Treasury Secretary Janet Yellen called on Congress to pass legislation to regulate the tokens.
Although Tether quickly recovered, fear persists that Tether’s reserve may not be sufficient. In February 2021, the New York attorney general ordered Tether and Bitfinex to stop operating in the state after an investigation found the stablecoin provider had made “false statements” about USDT’s support.
According to a 10-page report prepared by an accounting firm, Tether had $4 billion in actual cash in its reserves at the end of the first quarter of 2022, which is only about 5% of its total liabilities.
Tether has said that the stress test it weathered in May demonstrates its resilience. The company said a first-quarter 2022 audit showed it had $82.4 billion in consolidated total assets—its reserve—to support USDT.
How does USDT compare to other stablecoins?
There are a number of other stablecoins in the market and some are pegged to hard currencies like USDT, while others are supported by precious metals such as gold, or algorithms.
The No. 1 rival to USDT is a stablecoin called USD Coin, or USDC, which is controlled by a consortium that includes Circle, a crypto payments company, and Coinbase, the big publicly- traded cryptocurrency exchange. USDC’s market cap is almost as much as USDT, and the consortium is trying to attract its competitor’s customers by highlighting the strength of its reserve. It is composed entirely of cash and U.S. government bonds, which are considered the safest securities in the world.
Another stablecoin favored by crypto investors is DAI, which is managed by MakerDAO, a DeFi lender based on the Ethereum blockchain. DAI is an algorithmic stablecoin that is backed by other cryptocurrencies. It, too, rode out the collapse of Terra and is heavily used in popular finance platforms such as Aave, Uniswap, and Compound.
The bottom line
While stablecoins proved to be quite unstable in 2022, Tether, the pioneer in the market, weathered the storm and has reemerged as a go-to tool for crypto investors who want an easy way to toggle between traditional currencies and cryptocurrencies.
Yet, should a market crash or a legal entanglement once again raise questions about the strength of its reserves, Tether could face a run on the bank that drains funds if investors seek redemptions of USDT en masse. In crypto, there are no entities like the Federal Reserve or the Federal Deposit Insurance Corp. standing by to bail out a stricken institution and its depositors. Tether, and its customers, are on their own.