It’s a slow news day as BTC fluctuates between $40,000 and $41,000 after hitting an all-time high of $41,962 on Friday (January 10). So instead I’ll just take a shot at summarizing some of the recent chatter about Tether (USDT) and its relationship to Bitcoin (BTC) and other crypto-assets. But to get the real lowdown, I suggest you go to my main sources (Amy Castor, Frances Coppola, David Gerard, Trolly McTrollface and others that I link below).
Tether is the issuer of USDT, the biggest stablecoin by market capitalization. According to the Financial Stability Board, stablecoins are crypto-assets that aim to maintain a stable value relative to a specified asset, or a pool or basket of assets, or in the case of USDT the U.S. dollar. The main USDT use case appears to be as a crypto-asset trading on-ramp for residents of countries where there are crypto-asset trading bans and/or capital controls, and as a “reserve currency” for unbanked exchanges. USDT is the third largest crypto-asset by market capitalization ($24 billion versus BTC’s $760 billion) but in terms of trading volume it’s by far number one.
However, Tether’s relationship with the main crypto-assets, particularly BTC, with some claiming that USDT issuance is part of a BTC price pumping scheme. For example, a 2019 paper by John M. Griffin and Amin Shams found that BTC purchases with Tether “are timed following market downturns and result in sizable increases in BTC prices, and rather than demand from cash investors, these patterns are most consistent with the supply-based hypothesis of unbacked digital money inflating cryptocurrency prices.” See also David Gerard’s succinct description of the process in this Twitter thread.
But according to Frances Coppola, USDT’s asymmetric mechanics both support and disprove this claim. A recent paper by Richard K. Lyons and Ganesh Viswanath-Natrej used USDT deviations from its fiat currency peg to show that USDT acts as a “safe haven” for crypto-asset investors. They found evidence of significant premiums over parity during the crash in non-stable crypto-assets in early 2018 and during the March 2020 COVID-19 crisis. Discounts were found to derive from liquidity effects and collateral concerns. For example, USTD spiked to as low as around $0.90 in April 2017 when doubts were raging about the sufficiency of Tether’s reserves.
So, if BTC’s price is falling, investors wanting to cash out is likely to increase demand for USDT, which will in turn raise its price. In normal circumstances, arbitrage is probably sufficient to maintain the peg. But when Bitcoin is experiencing high volatility – in either direction – demand for USDT can increase far faster than arbitrageurs can bring it down. To prevent the dollar peg breaking, therefore, Tether must respond to this extra demand by issuing more USDT. And issuing more USDT increases exchange liquidity, making it easier to purchase or sell BTC and therefore feeding the price movement. “So wild swings in Bitcoin’s price might not be triggered by USDT issuance, but they most definitely can be fed by it.”
Adding some credence to these claims of shadowy motivations behind USDT issuance and usage are the widely held suspicions that it is only fractionally backed. Tether claims that USDT is always 100% backed by reserves. However, in addition to traditional currency and cash equivalents, according to Tether’s terms and conditions, they can also include “other assets and receivables from loans made by Tether to third parties, which may include affiliated entities.” Also, and possibly relatedly, the right to redeem USDT is not guaranteed: “Tether reserves the right to delay the redemption or withdrawal of Tether Tokens if such delay is necessitated by the illiquidity or unavailability or loss of any Reserves held by Tether to back the Tether Tokens, and Tether reserves the right to redeem Tether Tokens by in-kind redemptions of securities and other assets held in the Reserves.” (Crypto traders get around this by buying BTC with USDTs on an exchange that trades the BTC/USDT pair, wiring them to an exchange that trades the BTC/USD pair, and then cashing them out.)
There are other U.S. dollar-pegged and backed stablecoins out there. USDT remains by far the dominant one in terms of market capitalization ($23.7 billion), followed by USD Coin ($4.7 billion), Binance USD ($1.1 billion) and PAX ($0.4 billion). () Plus in the recent crypto-asset runup, none of the others have seen the kind of growth as USDT (+$29.1 billion over the last 12 months) The International Computer Science Institute’s Nicholas Weaver opines that if this USDT growth was truly organic, there would at least be some significant increase in the outstanding amount of the other stablecoins. (Fully-regulated Circle’s USDC has also seen substantial growth (+$4.3 billion over the last 12 months), albeit far overshadowed by Tether’s, is mainly on its heavy use in the rapidly growing decentralized finance (DeFi) market.)
Bryce Weiner believes that the whole crypto-asset industry depends on Tether staying in business and pumping out USDT, making Tether effectively too big to fail. I have no opinion one way or the other, but as a “coiner” it does give me pause for thought. And if anyone has any further thoughts on the topic, please let me know in the comments below!
* The views expressed herein are those of the author and should not be attributed to the International Monetary Fund, its Executive Board or its management.