What Is Tether? How Does It Work? – Forbes Advisor

Tether (USDT) is a popular stablecoin that crypto enthusiasts have used for years to leverage their cryptocurrency trades.

USDT is pegged to the U.S. dollar, and in theory it should be unaffected by the market volatility that can so dramatically impact the valuation of other cryptocurrencies, such as Bitcoin.

Tether Is a Stablecoin

Tether aims to provide a “safe” digital asset that maintains a stable valuation. That’s what makes USDC a stablecoin, whose value is pegged to the price of the U.S. dollar. The goal is that Tether should always maintain the same value as its peg.

“The idea is that 1 Tether can always be traded for $1, regardless of market conditions,” says Steve Bumbera, chief operating officer of Many Worlds Token.

Tether’s stablecoin competitors include USD Coin (USDC), Dai (DAI) and Pax Dollar (USDP), to name a few.

Crypto traders use Tether to provide steady, reliable liquidity to get in and out of other cryptocurrency trades without facing unpredictable losses (or gains) from volatile price changes.

Tether had a 24-hour trading volume of $89 billion at the time of this writing. That makes Tether the most liquid cryptocurrency—beating even crypto market stalwarts Bitcoin (BTC) and Ethereum (ETH). It’s also among the top three largest cryptos by market capitalization.

How Does Tether Work?

When a user deposits fiat currency into Tether’s reserve, selling fiat to buy USDT, Tether then issues the corresponding digital amount in tokens. The USDT can then be sent, stored or exchanged.

If a user deposits $100 in the Tether reserve, then in keeping with a 1-to-1 dollar parity, they will receive 100 Tether tokens. Tether coins are destroyed and removed from circulation when users redeem the tokens for fiat currency.

Tether moves across blockchains like many other digital currencies. There are Tether tokens available on various blockchains, such as the original one with Omni on the Bitcoin platform as well as Liquid, in addition to Ethereum (ETH) and TRON (TRX), among others.

A Brief History of Tether

The roots of Tether date back a decade, to when J.R. Willet was looking to build new cryptocurrencies on the Bitcoin protocol. Willet implemented this idea with Mastercoin, and one of its original members would later become the co-founder of Tether in 2014.

Using Tether for liquidity began when it was added to the BitFinex exchange in January 2015.

Recent market turbulence, which saw the price of TerraUSD, another stablecoin pegged to the U.S. dollar, drop to less than $0.23, caused Tether to break its $1 value, crypto experts say.

The decline was largely driven by investors’ fears that if one stablecoin can break its peg, others can, too.

“As an asset-backed stablecoin, with holdings primarily in U.S. Treasurys, [Tether] stands a far better chance of weathering the current tsunami rocking the digital asset world,” says Marc LoPresti, managing director of The Strategic Funds. He says the only stablecoin with comparable collateral quality is USD Coin.

“It is difficult for Tether to follow the path of Terra completely because if they decide to take out even 30% to 50% of their collateral, that will shake up not only the crypto market but also the broader financial markets,” says Kavita Gupta, founder and general partner of Delta Blockchain Fund.

How Is Tether Backed?

Despite stablecoins being a popular choice among crypto traders, Tether has some additional controversies regarding liquidity issues and whether its reserves are adequate to cover the number of USDT tokens in circulation.

According to Tether’s website in 2019, the site claimed the stablecoin was backed by reserves in traditional currency and cash equivalents (and sometimes other assets from affiliated entities).

That’s a bit more detail than what is cited today. Today, Tether’s site states that “All Tether tokens are pegged at 1-to-1 with a matching fiat currency and are backed 100% by Tether’s reserves.”

Adam Carlton, CEO of crypto wallet Pink Panda, says Tether’s history of being transparent about how the coin is backed hasn’t always been clear or consistent.

“It has a very questionable legal past, and to this day, its actual reserves are still quite opaque and believed to be substantially composed of unknown sources of commercial paper,” Carlton says.

Other crypto experts say it’s somewhat accepted that Tether isn’t “fully” collateralized in the crypto marketplace. And that it was an issue of controversy more than a year ago.

“Markets have worked through that concept of how comfortable they are – it’s very clear Tether is not backed by dollars,” says James Putra, vice president of product strategy at TradeStation Crypto.

Tether vs. TerraUSD

Tether and TerraUSD (UST) are both stablecoins pegged to the U.S. dollar, but the two cryptos maintain their value using completely different methods.

Tether is a collateralized stablecoin, backed by the company’s assets and reserves. When those reserves are equal to or less than the number of tokens in circulation, the Tether is said to be “fully reserved.” You can see Tether’s current balances on its transparency page.

Terra is an algorithmic stablecoin. Instead of cash reserves in a bank account, Terra relies on programmatic language and the parameters its sets for another token on the Terra protocol to support the 1-to-1 U.S. dollar parity.

Based on its creation, the TerraUSD stablecoin relies on supply and demand market forces and LUNA’s ability to absorb price volatility to maintain its price peg.

Relying on an algorithm rather than cash reserves is what caused TerraUSD to lose its price peg amid recent market volatility. “Owning 1 UST, you would expect to be able to cash out for $1 at any point, but it lost its peg,” Bumbera says.

This has brought to light concerns over the future of such algorithmic stablecoins.

Binance, the world’s largest crypto exchange in trade volume, suspended spot trading for LUNA and UST temporarily against its own stablecoin BUSD on May 13 because of its volatility, with LUNA’s value going down to near zero at $0.0001208, at the time of this writing.

“The current version of the programmatic coins is definitely over,” Gupta said. “But there will always be a space for innovation in a much better stablecoin.”

Tether’s price slipped below its peg to $0.9485 in market moves related to the collapse of TerraUSD on May 12 but has since rebounded close to its 1-to-1 dollar parity.

Tether vs. Bitcoin

The key difference between Tether and Bitcoin is that “Tether is a stablecoin … tied to a real-life commodity, the USD, while Bitcoin is not tied to any real-world commodity,” says Daniel Rodriguez, chief operating officer at Hill Wealth Strategies, a wealth management firm in Richmond, Virginia.

Tether is a centralized crypto, whereas Bitcoin is decentralized by not being linked to any real-world currencies. For that reason, in theory, Tether’s value should remain more stable than Bitcoin’s.

Cryptocurrencies that are not pegged to a real-world asset or currency are subject to market volatility. Most traditional cryptocurrencies like Ethereum, Bitcoin, and Litecoin (LTC) will see extreme fluctuations and volatility with the market, inflation and interest rates.

“Tether seems to be a little more stable because it stays close to the value of one USD, give or take a few cents,” Rodriguez says.

Another distinction is that “Tether isn’t designed to necessarily make money but rather be a stable store of value,” he adds.

Is Tether a Good Investment?

Stablecoins like Tether don’t make much sense as an investment because they aren’t meant to increase in value. They only operate as a store of value, since one USDT should always equal one dollar.

Besides being a useful store of value, the benefit of Tether is as a tool for conducting business in a far simpler manner than using Bitcoin.

“One Bitcoin today will not be the same price of Bitcoin tomorrow, making it incredibly difficult to create pricing schemas for companies based solely on BTC,” says Bumbera.

One good reason to own a stablecoin such as USDT, Bumbera says, is if you want to keep your money in crypto but want to avoid volatility. But even staked to the U.S. dollar, Terra is far from a safe investment.

“The risk would be Tether losing its value or the staking platform chosen is not legitimate,” Bumbera says.

While the company purports that it “never once failed to honor a redemption request from any of its verified customers” to date, nothing in investing or cryptocurrencies is guaranteed.

Cryptocurrency users also need to be aware of the changing regulatory landscape around digital assets.

“The future of Tether and other stablecoins depends on transparency, (and the) sufficiency of collateral and liquidity,” LoPresti says. “These features will be the focus of regulators, who will undoubtedly focus their efforts on this sector of the digital asset economy due to the collapse of TerraUSD.”