Blockchain technology has just entered its teenage years, and from this point, we can say that it has matured into a thriving industry with a vast range of products aimed at different user needs.
Bitcoin has done a great job of helping people overcome the initial resistance towards decentralized finance. With around 40% dominance of the total market, it remains the key player in the field. However, at this point, all that crypto excitement isn’t about Bitcoin anymore as it seems that the whole enterprise world is looking for fresh markets.
New cryptocurrencies with different purposes are popping up every day, including crypto assets aiming to stabilize the unbearably volatile nature of the cryptocurrency market. These assets are called stablecoins, and that’s exactly what we’re discussing in this article, through the features of the first and most popular stablecoin — Tether (USDT).
Why Is There a Need for Stablecoins?
Cryptocurrencies have turned out to be poor mediums of exchange because of their price instability. Even the most crypto-enthusiastic merchants are reluctant to adopt digital currencies as a regular payment method because crypto prices can plummet over 50% before you know it without any warning. For example, Microsoft was one of the first giant brands that foresaw the power of cryptocurrencies, but even they were forced to temporarily cease Bitcoin payments in 2018 because of the asset’s tectonic price shifts.
Stablecoins appeared as a response to the volatility issue, which — together with the low scalability — prevents a free flow of crypto assets outside the blockchain ecosystem.
At this point, you’ll probably ask: hasn’t fiat money already helped crypto reach its maximum potential now that all cryptocurrency exchanges allow cash withdrawals and fiat deposits? Well, even though the interaction between fiat and crypto is quite possible today, it doesn’t fully help cryptocurrencies build the flexibility that is essential to operate as a medium of exchange.
There are many crypto services where you can easily buy or sell Bitcoin and other popular altcoins in exchange for your local currency with guaranteed liquidity. However, such conversions are inconvenient for active day traders, first because they are extremely costly and time-consuming and second because they’re limited to certain exchanges and geographical territories. To illustrate, a given crypto exchange may not support your native currency and/or may charge over 5% per transaction for fiat deposits and withdrawals.
What Are Stablecoins?
Stablecoins are a class of digital assets that strive to sustain price stability by being backed by the value of a more stable asset such as fiat currency or gold. However, they’re cryptocurrencies in nature — stablecoins run on a blockchain, which enables sleek interaction with other cryptocurrencies in a trustless and cost-effective manner as well as access to the DeFi world.
Stablecoins can be “tethered” in a 1:1 ratio to fiat currencies such as USD or Euro, commodities like gold or silver, or even other more consistent crypto assets. For each unit of a given stablecoin, there is a corresponding asset held in reserve funds that guarantee the value of that stablecoin.
The first stablecoin, BitUSD, was launched in 2014 as a crypto-backed token pegged to the core token of the BitShares network (BTS) and a range of other cryptocurrencies locked in a smart contract to serve as collateral. The entire project was ambitiously envisioned by the industry leaders Dan Larimer and Charles Hoskinson, creators of EOS and Cardano (ADA), respectively.
However, it wasn’t until Tether (USDT) came along in 2015 on the Bitfinex exchange that the idea of digital assets backed by physical assets really took off. Tether allowed easy access to the DeFi ecosystem with lower transaction fees.
Today there are nearly 100 stablecoins, including best-sellers like USD Coin (USDC), Binance USD (BUSD), TerraUSD (UST), Dai (DAI), and Pax Dollar (PAX).
How Do Stablecoins Work?
As mentioned, stablecoins can use multiple assets, including fiat, gold, another crypto, and even algorithmic functions as collateral. The collateral currency is the main indicator of the legitimacy, on-site stability, and overall performance level of the stablecoin.
Each unit of a fiat-collateralized stablecoin is backed by 1 unit of the underlying fiat currency, meaning there is a fiat currency unit in reserve for each stablecoin unit in circulation.
When a trader wants to cash out a certain amount of stablecoins, the company running that stablecoin withdraws the fiat amount from their bank reserve and sends it to the user’s bank account. Then, the management removes the received stablecoins from existence by burning them.
Precious metals can also serve as a backup currency for stablecoins. The requirements are almost the same as fiat-collateralized cryptocurrencies except for the measurement units imposed by the different nature of commodities. Gold-backed stablecoins allow you to purchase, trade, and keep gold without worrying about the transportation and the occasional illiquidity of physical gold.
The most popular gold-pegged cryptocurrencies are Tether Gold (XAUT), Paxos Gold (PAXG), DigixGlobal (DGX), and Gold Coin (GLC).
Crypto-backed stablecoins haven’t gained any considerable momentum yet, simply because cryptos don’t make stable underlying assets. In most cases, they’re created to distribute and soften the risk of the price fluctuation of their collateral coin.
The mechanism for developing crypto-backed stablecoins is more demanding than using real assets as collateral. For instance, you may need to deposit $600 worth of Ethereum (ETH) to produce $300 worth of stablecoins. In this case, the ratio is 2:1, and even if the pegged crypto price falls 25%, the $300 worth of stablecoins are protected by $450 worth of Ethereum. One of the few popular crypto-backed stable coins is MakerDAO’s Dai.
Algorithmic stablecoins don’t have a backup asset but utilize a computer algorithm to maintain the coin’s value and prevent unpredicted fluctuation. If the value of such a coin is pegged to $2, for example, and the demand for that stablecoin starts rising, then the algorithm will generate more coins to regulate inflation.
There aren’t any distinguished representatives among algorithmic stablecoins yet — except maybe for the Ampleforth (AMPL) stablecoin. It’s difficult to implement the idea in practice as stablecoins require a support level of demand for sustainable stability and real-time price information all the time.
What Is Tether (USDT)?
Originally known as Realcoin, Tether (USDT) is a stablecoin created by Brock Pierce, Craig Sellars, and Reeve Collins in order to “soothe” the crypto market’s instability. Tether is a product of Tether Limited, a large corporation with headquarters in Hong Kong. The company handles the USDT token reserves, mints and destroys Tether tokens based on supply and demand dynamics and distributes fiat withdrawals.
Tether is backed by the US dollar and operates as the native token of the Tether network. You can recognize it under the USDT symbol on the crypto exchange lists. It’s easily transacted with Bitcoin since it’s created on the Omni Layer, a native system of the Bitcoin blockchain, and maintained on Liquid, another Bitcoin sidechain. It’s also available on other blockchains, including Ethereum, EOSIO, and Tron. In fact, the Ethereum community makes the largest market for Tether.
How to Invest in Tether?
Stablecoins combine the best of both worlds — they are immutable and transparent like cryptocurrencies, and they have the price stability of fiat currencies.
Stablecoins function like digital cash, and you can use them in the following on-chain activities:
- Trading — you can replace the BTC/USD pair with BTC/USDT to reduce costs and waiting times. The number of stablecoin-to-crypto pairs has exceeded the number of fiat pairs on the world-renowned crypto trading platforms like Binance, Coinbase, Kraken, and KuCoin. You can also find plenty of cryptocurrency exchanges where you can buy Tether with your native currency (in Canada, you can always turn to NDAX).
- Staking and lending — stablecoins are dominant lending assets since lenders avoid devastating losses caused by sudden price shifts. Some well-established exchanges will pay you a handsome interest rate just for storing Tether on their platforms. This rate can vary depending on the exchange. For example, you can earn 9.50% on BlockFi, 10% on Binance, and 12% on Nexo using your USDT holdings.
- International Payments — stablecoins can be used for instantaneous worldwide value transfers since the crypto market has no working hours.
How Does Tether Make Money?
Since Tether isn’t designed to rise in value, even experienced brokers wonder how it earns revenue to support its operations. The logical explanation is that Tether manages to make a living the same way as insurance companies — charging fees and investing its USD reserves in profitable business activities like loans and institutional bonds.
For illustration, the iFinex holding company that stands behind both Tether and Bitfinex earned a net profit of $730 million over the past couple of years. However, they aren’t very transparent when it comes to their stakes in external businesses. For example, in 2021, Tether lent $1 billion to Celsius Network, another crypto lending service, and that’s all we know about iFinex investment activities in the recent past.
The official version is that Tether earns generous profit from verification, deposit and withdrawal fees. For example, the company incurs a $150 fee for account verification on their native platform in case you want to withdraw and deposit cash using Tether. Moreover, the company charges fees for processing fiat withdrawals and deposits.
Tether was first listed on the BitFinex exchange in 2014, gaining immediate traction among the Bitcoin community. However, the asset has been the subject of various controversies since its launch.
Soon after Tether’s launch, researchers revealed that Tether and Bitfnex had the same CFOs and CEOs, sounding the alarm that not all may be well and above-board in Tetherland. Researchers alleged that Tether was artificially pushed on the market to boost Bitfinex liquidity and that Tether’s manipulation actually caused the first bull run of Bitcoin in 2017 when BTC unexpectedly hit $20,000.
That very same year, Tether became a victim of a $31-million worth hack attack, which led to the creation of a hard fork. Despite this, Tether was doing pretty well on cryptocurrency exchanges, rapidly expanding the supply of new tokens. In January 2018, the company had already released over 2.4 billion Tether units, but none of the industry experts believed that Tether actually owned the backup cash reserves in this amount. Moreover, Tether appointed the prominent accounting company Friedman LLP to perform an external balance sheet audit in 2017. This audit was supposed to finally prove that Tether had enough dollar reserves, but for unknown reasons, it was never completed.
Two years later, New York Attorney General Letitia James blamed Tether’s parent company for covering an $850 million loss using the Tether reserves. Even though Tether denied the allegations, the company made a settlement with the state and agreed to pay $18.5 million. Tether also stopped its operations in New York as part of this agreement.
A new series of allegations came forward in the summer of 2020, resulting in a class action against Tether. Tether was accused of issuing and assigning new USDT units to itself and then selling them to Bitfinex. Despite the seriousness of these claims, the case was never brought to trial.
In October 2021, Bloomberg reported that Tether faced yet another accusation regarding the legitimacy of its reserves. Allegedly, Tether didn’t have the cash reserves to back USDT and had loaned millions of dollars to large Chinese corporations and other crypto services.
Is Tether Legit?
The Tether company has always claimed it has enough cash to meet all pay-out requests per day and that nothing can undermine the company’s image in the near future.
And they seem to be right. The demand for Tether has never been higher. At the beginning of 2022, the market capitalization of Tether rose to $78.426 billion compared to the $24.295 billion market cap in January 2021.
So, it’s beyond question that Tether has become an integral element in the crypto industry. As a matter of fact, giant trading platforms like Binance and Huobi hold the largest amounts of USDT. The point is that if Tether fakes its reserves as many experts claim, then all those billions held by exchanges will end up having zero value, creating a critical liquidity problem.
A Few Words Before You Go…
Tether isn’t a one-off cryptocurrency investment — it’s a dynamic digital asset that reduces the costs of fiat to crypto transactions.
Tether’s price isn’t expected to rise, as it’s the case with the largest cryptocurrency products — BTC, XRP, ETH and all range of ERC-20 tokens. Even though Tether coins are eventually redeemable, there is no point keeping them in crypto wallets and waiting for happier times.
But if you’re an active trader, stablecoins can really improve the quality of your crypto life or help you earn a lucrative passive income from staking and lending activities. Despite the continuous disputes with regulators, Tether has always enjoyed users’ trust across all crypto markets.