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Overview
Formerly known as RealCoin, US Dollar Tether (USDT) was established in 2014, making it one of the oldest stablecoins. USDT is a cryptocurrency that leverages distributed LEDGER technology to allow individuals and organizations to store, send, and receive digital tokens pegged primarily to US dollars (USDT), but also euros (EURT), the Chinese yuan (CNHT), and gold (XAUT). Tether tokens can be quickly sent and received in peer-to-peer fashion over multiple blockchains across the globe and for a fraction of the transaction costs of many legacy payment networks.
Tether Strengths
- Liquidity and market dominance: USDT is one of the longest-running stablecoin with the most liquidity and exchange listings. Its network effects have given it a sizable lead in the stablecoin market with nearly 70% dominance.
- Price stability and track record: USDT has a significantly longer history of (almost) perfectly holding its dollar peg, thereby earning the trust of many traders.
- Exchange listings: Tether is supported by nearly all exchanges including many of the largest and most trusted.
Tether Weaknesses
- Centralized project with an unscrupulous team : Counter to the cryptocurrency ethos, USDT is completely centralized around one company and asks that its user completely trust this single-point of failure. Additionally, the company has already been exposed as lying about its “one-to-one US dollar backing.”
- Lack of transparency and audits: Tether’s minting process and auditing practices operate in a “black box” with little transparency.
- Unclear banking relations and regulatory status: Tether Limited, over the course of its existence, has jumped from one banking partner and regulatory jurisdiction to another, raising concerns over the project’s legitimacy and legal standing.
- Counterparty risk: Tether Limited is on record as stating that holding Tethers provides no legally enforceable rights to a US dollar for the holder. Users are also reliant on Tether’s relationships with banks outside of the high standards enforced in the US.
Important Links
- Website
- Whitepaper
Use Case
Tether (USDT) is a currency that represents the price of US dollars on public blockchains. It’s commonly known as a “stablecoin,” a digital currency anchored to the price of an underlying asset (Ex: US dollars, euros, yuan, gold), redeemable 1-for-1 with the underlying currency. Each USDT is an IOU issued by Tether Limited, which entitles users to dollar deposits at Deltec bank in the Bahamas.
USDT benefits holders as a dollar-denominated bearer asset whereby possession is described by a private key that can permit a spend without depending on a third-party. Its transactions are auditable by anyone on publicly accessible blockchains, and the price stability garnered from the price of US dollars enables traders to mitigate volatility risk in the greater cryptoasset market. Further, a dollar-peg enables USDT as a functional form of collateral in crypto-finance along with opening arbitrage opportunities where asset prices differ across exchanges.
The USDT-ETH trading pair has a clear pattern of heavy usage from about 2:00 to 16:00 UTC, corresponding to the Asian and European stock markets hours. Transfers drop off towards the end of the day after 20:00, which coincides with the closing of the New York Stock Exchange each day. This usage pattern provides further evidence to the theory that Asian traders are responsible for the explosive growth in USDT supply since the beginning of 2020, surpassing $62 billion.
Future Use Cases
As a global asset tethered to the US dollar, USDT could presumably provide exposure to the assurances of the US banking system in countries with weak or restrictive trade laws. Further, merchant adoption of crypto stablecoins could enable a common form of payment worldwide, effectively advancing global commerce to settle transactions in minutes and operate 24/7/365. In perhaps the most extreme scenario, as a digitally common tool to transact value that relies on a shared infrastructure (public blockchains and open standards, e.g. Ethereum/ERC-20), USDT could instantiate an entirely new, natively-interoperable system of finance.
Competitive Advantage
USDT, formerly known as “RealCoin,” was released in 2014 as one of the earliest stablecoins created, and today is the most widely used. All coins are issued by associated company Tether Limited which notably has the same founders as Hong Kong-based exchange Bitfinex. It’s become blockchain-agnostic having been deployed on nine public blockchains including Algorand, EOS, Ethereum, Bitcoin (Liquid & Omni), Bitcoin Cash, Tron, OMG Network, and most recently, layer-one Ethereum competitor Solana. Hypothetically, it could also launch on Bitcoin’s scalable layer-two network, Lightning, as it’s rumored Tether has contributed undisclosed funding to Lightning’s issuance protocol RGB.
Figure 1. Distribution of USDT on several blockchains.
A cash-equivalent digital currency (especially one tracking the world’s reserve currency) enables investors to curate more complex trading strategies and developers to create more complex financial applications. While USDT has centralized and decentralized stablecoin competitors in USDC and DAI, relative trading volume has indicated USDT is entrenched in the broader market beyond its adoption as a first-mover. Thus, its greatest competitive advantage is perhaps its liquidity. Being highly available (listed on exchanges and public blockchains) and mostly maintaining its dollar-peg over time has proved its safety and depth to speculators, merchants, and hodl-ers alike.
Challenges to Adoption
The largest hurdles for USDT are legal compliance and competitors. While USDT has proved product-market fit with users, it has struggled to maintain banking relationships and accrue confidence from government officials. USDT (collectively on Bitcoin, Ethereum, Tron, EOS, Algorand, and other blockchains) has a circulating supply of over $65 billion, despite Bitfinex’s legal issues and a fraud dispute involving Tether with the New York State Attorney General’s office in April 2019. Despite the legal issues, Tether’s market cap swelled beyond $60 billion this year, more than 5x where it started. Some clarity came to this legal matter in February 2021 when Tether and Bitfinex reached a settlement with the New York Attorney General’s Office. Under the terms of the settlement, Tether did not have to admit any wrongdoing but did pay an $18.5 million fine. The investigation took over two and a half years and for Tether to come out of the matter with only a small fine can only be viewed as a win for the project. The settlement resolved the allegations about the $850 million loan Tether made to Bitfinex when Bitfinex was having issues accessing funds. The loan was repaid early and in full, including interest. At no point did the loan impact Tether’s ability to process redemptions.
Other stablecoins may be capitalizing on USDT's legal troubles, especially USDC. Over the last year, USDC's growth has outpaced USDT and eaten into the overall stablecoin market share. Should governments, especially the US, crackdown even further on stablecoins, USDT would almost certainly be affected to a greater extent than USDC due to its lack of transparency and tenuous banking relationships. In fact, USDT issuance has flatlined over the last several months (chart below).
Outside of connections to accept dollar deposits, Tether incurs substantive legal risk. Tether was issued a subpoena from the US Commodity Futures Trading Commission (CFTC) in 2017 along with an allegation of manipulating the price of Bitcoin during the 2017 bull market. Additionally, Tether is limited or restricted for use in the following areas: Cuba, North Korea, Iran, Pakistan, Syria, Venezuela, Crimea, and the US.
Additionally, the very idea of stablecoins or “crypto dollars” have come under attack from US regulators as the STABLE Act was proposed in December 2020. The STABLE Act was written with “the intent to prevent abuse, opacity, and the potential rise of a stablecoin-based shadow-banking system.” However, the obligations that stablecoin issuers would have to abide by in order to avoid breaking the law are incredibly cumbersome and/or restrictive.
Firstly, any stablecoin issuer would be required to obtain a federal banking charter. In addition, any stablecoin issuers would be required to obtain the approval of both the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) six months before issuance. Finally, the stablecoin issuers would either need to obtain FDIC insurance or deposit dollar reserves directly at the Federal Reserve.
In addition to financial and legal risk pertaining to Tether, users are subject to security risk — security from attackers and security maintaining the US dollar peg. In November 2017, roughly $31 million were stolen from Tether. Notably, as Tether Limited isn’t a US-regulated bank, users are outside the promise of FDIC-insured bank accounts that guarantee withdrawals up to a threshold of dollars. Ultimately, as a centralized entity, users must trust Tether Limited to responsibly custody deposits.
Additionally, USDT hasn’t always reflected fully-backed dollar reserves or a dollar-pegged value. Despite a solvency report released to the public in 2017 which indicated a fully-backed USDT supply, a roughly 74% backing was revealed by Tether’s General Counsel in a 2019 Supreme Court hearing in New York. The Hong Kong-based exchange lost access to $850 million following the New York Attorney General’s office arrest of two men accused of laundering money through a shadowy payment processor called Crypto Capital that Bitfinex had leveraged for banking services.
In May 2021, Tether released the first of its NY Attorney General reserves reports. These quarterly reports are required by Tether for the next two years as part of their settlement with the NYAG. What is notable is that only ~75% of the reserves are backed by "cash and cash equivalents" and less than 4% by actual cash. 65% of "cash equivalents" are in commercial paper which is more volatile and less liquid than actual cash. Fiduciary deposits formed 24% of the category, reverse repo notes 3.60%, and treasury bills about 3%. This is a far cry from a company that touted a one-to-one backing in cash just a couple years ago.
Lastly, Tether’s history of blacklisting addresses, freezing funds, and complying with regulatory pressures pose remarkable censorship risks. In 2020 alone, 84 addresses have been blacklisted, meaning the funds held by these wallets are completely unusable.
In October 2020, Tether froze $300,000 worth of USDT after the LAPD reported a theft involving hackers stealing private key information from note-taking app Evernote. The keys were used to authorize spends from the owner’s wallet to the hacker’s wallets. Subsequently, the US government is finalizing the seizure of the USDT, stating the hackers are in violation of Section 1030 of the Civil Forfeiture code for “fraud and related activity in connection with computers.”
The increase in blacklisted addresses and regulatory pressure is trending in the wrong direction for crypto natives aspiring for censorship-resistant; however, this may bode well for competing Ethereum stablecoin DAI which has functioned in a permissionless manner since its release in November 2019.
