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What is US Dollar Tether and should you be careful using it?

Morning cryptocurrency fans, I was up late last night reviewing US Dollar Tether (USDT). It is a currency that I have used for around two years and have been very happy with it. However, there have been some wholesale changes to it, so it is worth recapping. I have also been careful about storing too much value in this currency. This is blog about my current thoughts and findings on this currency.

 

So for beginners, US Dollar Tether is a cryptocurrency that has a specific purpose; to retain the same value as a normal US Dollar. Cryptocurrencies are notoriously volatile, it’s one of the reasons why myself and many other people trade them.They are volatile because their values are socially constructed based on a range of perceptions, I posted a blog relating to this here. So they often drastically change in value based on world events, technology updates, announcements or developments. There is also general hysteria, which seems to be gripping the cryptocurrency sector at the moment and something called “pumping and dumping” – which is another story. Anyway, it is the aim of USDT to avoid these drastic changes in value and provide the benefits of traditional fiat money: a relatively stable store of value, with the benefits of cryptocurrency: instant and flexible global payments. There also seems to be a secondary benefit: as it is technically not a real USD the exchanges are not required to meet strict money laundering and Know Your Customer (KYC) restrictions. This benefits exchanges like Poloniex that only trade in cryptocurrencies.

So how does US Dollar Tether achieve its aim of a stable cryptocurrency at parity with the US Dollar? Well this actually relates to another the other blog where I discussed how we value ‘community currencies.’ USDT aims to achieve parity with the US Dollar through being ‘backed’ 1-for-1 with real US Dollars. This is done through its parent company Bitfinex – which is one of the world’s largest Bitcoin exchanges and based in Taiwan. Within its bank account it holds $1 for every 1 USDT in circulation. According to Coinmarketcap as of today, there are 127,493,815 USDTs in circulation, which in theory means there is $127,493,815 in Bitfinex’s bank account. In theory anyone holding 1 USDT could go to Bitfinex and demand it be swapped for $1. Why I repeat “in theory” – well this is the bit that investors must be careful with. The whole point of cryptocurrency is to be able to exchange value without requiring the consent of a central institution. This is why Bitcoin is used on darkweb markets, because there is no central institution able to restrict its exchange. Relying on Bitfinex to ensure that there is the corresponding number of USD in a bank account is relying a range of institutions to ensure the value of USDT. Not only are we relying on Bitfinex, we are relying on its bank and also the US Government. Also, in the small print of Bitfinex Terms and Conditions it actually states; “There is no contractual right or other right or legal claim against us to redeem or exchange your Tethers for money. We do not guarantee any right of redemption or exchange of Tethers by us for money. There is no guarantee against losses when you buy, trade, sell, or redeem Tethers.” Although this could just be to ensure they meet legal requirements.

 

Considering the different institutions that are needed to ensure the parity of US Dollar Tether must be remembered when trading with it. What gives it is price stability is also a major point of weakness. This was highlighted in two separate incidences recently. The first was when a financial audit of Bitfinex in March found a large discrepancy between USDT is circulation and USD in its bank account. The companies response was based on the quote above. I am torn about the implications of this. The entire banking system operates on a “fractural reserve” – which means that there although everyone’s money is in theory in the bank, most of it is actually being lent out. It works because not everyone wants to draw out their money at once, unless it’s a bank run, and that’s when it goes to s**t. Bank runs are avoided by the state guaranteeing deposits, that would definitely not be the case for Bitfinex. But it may be ok as not everyone wants to exchange their USDT for $1 at the same time, and even those who do, USDTs are currently in high demand. According to Coinmarketcap the third biggest exchange is USDT/USD at Bitfinex, but this was only 7.62% of total volumes over the last 24 hours. In theory, as long as Bitfinex have that $16,031,100 available, there is the perception of stability that ensures the value of the total $127,493,815. The second area of concern is the USD. Remember, even if a USD is sitting in a bank account in Taiwan, it is still technically under the control of the US Government. This is what geopolitical analysts describe as an extension of an “sovereignty regime through a currency process” – which basically means that if you use a currency, you abide by the issuers rules. So having $127,493,815 sitting in a bank account in Taiwan means it could be frozen by the United States and its wider financial network. This is what has been witnessed in April, where the wider financial network is restricting the ability of USDT to function. This restriction only applies to Taiwan > USA transfers, as depositors in Taiwan are still able to withdraw their funds. I wonder if the US Government will seek to pressure the Taiwanese Government to restrict withdrawals in the Taiwan – a true sovereignty regime would be demonstrated then.

Ok, what to take from all of this? Firstly it is an interesting example of how cryptocurrencies are valued and are developing. However, I do worry about the short-medium term stability of the USDT in its current format. As it is reliant on Bitfinex, in theory it could be shut down overnight, that would have drastic consequences for the value of the USDT. Potentially if the USD backing is removed, the USDT would still hold some value, as people do use it. However, it would just be open to the same volatility of other cryptocurrencies and there would be no guarantee it would keep a value of a dollar. I would tread carefully when using it. Do not hold a huge amount of value in USDT, maybe just use it for short term trading strategies. Be wary that there are a couple points of failure that could undermine its value and its ecosystem. Hope this was interesting. Happy trading.

Stuart Bowles

Stuart Bowles

Stuart Bowles is a PhD Candidate at the University of Birmingham. He has background in sustainability, socioeconomic processes, financial innovation and social enterprise. His PhD explores the role alternative financial innovations including cryptocurrency will have in society, especially towards meeting the objectives of sustainability.

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Bitcoin - 1H2mtJDNnAiLNhn8wG3awfW7Ko6Vw8PqYB
Litecoin - Lg74CDbpbxYEoY1JEeiG5DzUtpKYW9KcP8
Ethereum - 0x09f0de6bb78d22e16e292a38bc05a2b5bd6f1d57
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Golem - 0x09f0de6bb78d22e16e292a38bc05a2b5bd6f1d57
Augur - 0x09f0de6bb78d22e16e292a38bc05a2b5bd6f1d57
Iconomi - 0x09f0de6bb78d22e16e292a38bc05a2b5bd6f1d57
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