Overview

While Bitcoin and Ethereum together make up nearly 60% of the total market cap of cryptocurrencies, the third largest token by market cap is USDT, the leading stablecoin.

A common definition of a stablecoin is a cryptocurrency whose price is tied to a fiat currency, Stablecoins have centralized issuance or are run by a smart contract. The purpose of stablecoins is to mitigate the risks of sharp price fluctuations. Stablecoins also function as an intermediary between traditional finance and crypto.

What Is USDT?

USDT was launched by Tether in 2014. The company behind Tether is iFinex Inc (Hong Kong) who also owns the crypto exchange BitFinex.

USDT currently ranks 3rd by market capitalization and is also the earliest stablecoin pegged to USD. Therefore, Tether has gained a very large user base over the years. It is currently the most popular stablecoin with the largest circulation and most trading pairs.

In the highly volatile crypto market, investors seek to find a common and stable unit for more instant transactions. USDT was originally issued on Bitcoin Omni Layer, and later on Ethereum as an ERC-20 token. With the rapid increase in demand, USDT began to support more blockchains, such as Tron, Solana, Avalanche, etc.

Now USDT is almost everywhere. It can even be considered part of the infrastructure of the crypto industry. Almost all cryptocurrencies in the market have trading pairs with USDT, which shows how widely used it is by the market.

Price & Market Cap

USDT is the pioneer of stablecoins. Being the earliest and most popular stablecoin, USDT has a market capitalization of about 67.5 billion U.S. dollars.

Source: CoinGecko

The chart above displays the price changes of USDT from September 20, 2021, to September 19, 2022. Because USDT is pegged to the US dollar, the exchange rate should be exactly 1:1. However, when USDT first came into the market, the price was rather unstable. The exchange rate reached a maximum of 1.32 and a minimum of nearly 0.57. Fortunately, after these fluctuations, it finally stabilized at around 1 in the past year.

Source: CoinGecko

According to CoinGecko, USDT is one of the few leading cryptocurrencies in terms of market cap, but USDT’s market cap has not yet returned to the original level since its plummet in May this year. Due to the impact of the Terra Luna crash, USDT’s market cap almost experienced a free fall from close to 84 billion US dollars. USDT has not yet recovered its previous glory, making up only 40% of the market share of the stablecoins.

Because of the Luna crash, more and more people have lost faith in the so-called “stable” coins. For this reason, Tether issued a document in mid-June this year saying that Tether would destroy 10 billion USDT to stabilize its price, in an attempt to win the public’s trust back.

This move also shows that Tether has a large reserve and that Tether is able to meet a large number of withdrawal requests upon demand.

Source: Paolo Ardoino Twitter

How Does USDT Work?

According to Tether’s white paper, USDT maintained a one-to-one reserve ratio with the US dollar when USDT was first issued. For every USDT issued by Tether, one dollar will be added to the reserve at the same time. Each USDT token purchased is backed by one dollar in the real-world, in order to maintain accountability.

USDT’s nature is different from most cryptocurrencies. it is more of a unit of measurement that brings convenience to the exchange between cryptocurrencies and fiat currencies.

USDT’s Reserves

Tether’s Q1 report stated that its total reserve was $82.4 billion, exceeding its total liabilities of $82.2 billion. Tether’s market cap peaked in mid-May this year.

Reserve allocation

In Q2, 2022, Tether increased the reserve allocation of US Treasury bills which can effectively control the overall investment risks.

Earlier, Tether was criticized for holding too many bonds and commercial paper with higher risks than their yields. Today, Tether has cut its commercial paper holdings by 17% and increased its holdings of US Treasury bills, to ensure the stability of capital.

Reserves report

Although USDT is a stablecoin, in order to reduce risks, investors must make sure that USDT is indeed fully backed by US dollars with the help of public reserves reports.

However, Tether’s attorney stated in 2019 that every USDT issued was backed by only 0.72 USD. He later changed his statement and said that USDT is fully USD-backed. And Tether was not audited by a professional accounting firm according to the generally accepted accounting procedures. This is also the biggest controversy of USDT.

Previous reserve allocation

Generally, companies release financial reports or audit reports four times a year. However, after USDT as the absolute leader of stablecoins released its first audit report in 2017, the subsequent audit reports were released irregularly with certain contents not entirely disclosed. For example, before 2021, they only reported the total amount of funds they held but did not state in which financial instruments the funds were held. Only after June 30, 2021, did Tether’s reserves report begin to reveal such details.

It can be seen from the above chart that the reserve allocation of commercial paper has been decreasing, while the more stable funds and U.S. Treasury bills have been on a steady increase.

The surge in reverse repurchase in Q2 this year refers to security purchases in conjunction with the Fed’s tight monetary policy to recover excess funds in the market.

Controversies & Risks

As the biggest stablecoin by market cap, USDT is undoubtedly extremely successful. However, USDT is faced with multiple internal and external challenges, controversies, and risks.

Accused of being non-transparent

All states in the US have stablecoin regulators. The New York State Department of Financial Services (NYDFS) proposed three important stablecoin guidelines this year, including redeemability, reserve requirements, and independent audits. Tether has publicly stated more than once that the company has always been transparent about its asset reserves, and has hired multiple third-party services to produce audit reports. Tether is committed to disclosing complete and reliable information on its website. However, people still make assumptions about Tether’s corruption without actually doing their own research.

Tether is not without registration certificates. It is worth mentioning that Tether is registered in Wyoming, the state with the smallest population in the United States, in order for USDT to smoothly circulate in the United States. Tether is also registered as Money Services Business (MSB) under the US Financial Crimes Enforcement Bureau which requires casinos, financial institutions, insurance, money service business, and others to register, although compliance is not really taken seriously.

Tether’s white paper states USDT’s 1:1 reserve ratio, but Deltec Bank & Trust Limited Bank, Tether’s fund management service provider, has disclosed that the 1:1 peg is not true. From January 2020 to September 2020, Tether’s total assets only increased by 600 million US dollars while the total amount of USDT issued increased by nearly 5.4 billion US dollars.

Tether was criticized in March 2019 for changing the user terms to multiple its financial instrument allocations (no longer solely US dollars). Investors were upset because Tether did not keep its promises, raising the risks in investing.

Most people don’t realize that it’s impossible to just deposit tens of billions of dollars in a bank. The CTO of Tether said in an interview that banks require that you “must” invest in other assets. That is to say, the diversification of reserve allocation is dictated by the current financial system, rather than Tether’s desire to profit.

Wall Street is pessimistic about USDT

At the end of August this year, Tether had about $67.7 billion worth of assets and $67.5 billion worth of liabilities, meaning that Tether should not be accused of over-collateralization. Wall Street pointed out that if Tether’s reserves fell by 0.3%, there would be a run.

Ardoino, CTO of Tether, immediately responded that there is currently no problem for users to redeem assets, and Tether will never repeat the failure of Terra. He also said that the decision to destroy $10 billion in mid-June is still going to be enforced which makes it obvious that everything is fine at Tether and there is no possibility of insolvency.

Shorting of USDT

Due to UST’s failure in May this year coupled with the overall economic depression, and the Federal Reserve raising interest rates, the global financial market has been suffering.

As of the time of writing, the market value of USDT has decreased by about $16 billion from the high of $83.1 billion in May, which has led to many investors using Genesis Global Trading (a crypto brokerage company) to short USDT, which made the price of USDT to drop further to 0.94 USD at one point.

What’s more, there is a serious imbalance in the Curve 3pool liquidity pool, which includes the three major stablecoins USDC, USDT, and DAI. These three stablecoins could be freely exchanged, but the heavy hit in May destroyed the balance and as a result, the proportion of USDT in the pool reached as high as 64.9%, which means converting to USDT would be an unfavorable choice.

Source: Curve

Source: Dune

Fortunately, USDT survived the attacks from the market and restored its 1:1 peg in a very short period of time.

Challenge from the rising stars

As far as market cap is concerned, USDT and USDC are ranked third and fourth, but USDC doesn’t fall far behind.

Compared with USDT, USDC has strong reserves for over-collateralization, publishes reserves reports regularly and transparently, and has guaranteed market liquidity. Even in a bear market, the market cap of USDC still hit a new high. There are many voices that USDC will replace the stablecoin leader USDT and leap to the throne soon. Arcane, a blockchain data research company, synthesized various data at the end of last year and predicted that USDC may surpass USDT to become the biggest stablecoin in the second half of 2022.

USDT Is Reborn

Decentralization & market order

In early August this year, the U.S. Treasury Department added the addresses involved with Tornado Cash, a cryptocurrency mixer, to the Office of Foreign Assets Control’s (OFAC) SDN control list, and called Tornado Cash “a threat to U.S. national security”. This is the first DeFi project to be sanctioned, and all addresses that interact with it are blacklisted.

The government regulations have entered the crypto world already, trying to establish a strict regulatory system to implement centralization. Many DeFi exchanges, such as dYdX, Uniswap, Aave, and the centralized exchange Kraken, all had to block the accounts that were once involved with Tornado. Circle, the issuer of the second biggest stablecoin USDC, froze 44 addresses that interacted with Tornado Cash.

Tether, however, has publicly stated that it will not freeze addresses tied to Tornado Cash unless it is strictly required by the government. Tether suggested that freezing those addresses would be premature before receiving a firm order, because it could disrupt the market and cause irreparable losses, and may even jeopardize global regulatory efforts.

Many communities and investors praised Tether for not adhering to decentralization. Many of them even sold USDC for USDT to show their support. Within a month, about $1.6 billion from USDC is transferred to USDT, causing the market cap of USDC to drop by 2.4% and about $1.3 billion to evaporate, while the market cap of USDT increased by 2.59% within the same month.

Source: CoinMarketCap

Reserve allocation change & monthly proof-of-reserve reports

In order to meet investors’ expectations, in July, Tether and the Italian branch of BDO International, the fifth largest accounting firm in the world, jointly announced that it will release monthly public reserves reports.

Tether also reduces the proportion of commercial paper holdings, creating a healthier investment environment. According to Tether’s latest August report, commercial paper holdings fell by about 58%, to $8.5 billion from $20 billion in the previous quarter.

Ardoino said that Tether is expected to reduce commercial paper holdings to zero at the end of October.

Circulation rebound

After reaching its peak in May this year, USDT finally begins to show signs of recovery. The graph below shows the first time that USDT minted coins in the past three months, which pumped its market cap by 0.85% ($560 million). Although this is only a small increase, it still has brought considerable circulation to the market..

Source: CoinMarketCap

Market’s test

Ardoino said that Tether can handle a large amount of capital circulation, and has never failed to do so. Tether once processed nearly 7 billion withdrawals in just 48 hours, which is higher than 10% of the total reserves at that time. Tether also once handled withdrawals amounting to 16 billion in a month, which was about 19% of the total reserves at that time. Even traditional banks may not be able to handle such situations smoothly. Just think about Lehman Brothers. It’s safe to say that as the stablecoin with the most users, Tether can indeed withstand market winters and live up to our expectations.

Conclusion

After the crash of UST in April 2022, the domino effect-like liquidation crisis caused extreme fear and panic sell. USDT quickly became the focus of the market. Fear and irrationality led people to sell USDT for less than 1 USD, causing a brief de-pegging in the secondary market.

Even in the face of such a large liquidity crisis, Tether can still handle the $15 billion redemption effortlessly. The market’s panic about USDT de-pegging from USD was indeed amplified. As the oldest and most widely used stablecoin, no matter what crisis and disputes, USDT still performs its most important duty - processing withdrawals.

What few people know is that Tether’s ambition is not just to establish itself as a dollar stablecoin but also to build a healthier forex market. With the peer-to-peer and access-free nature of crypto, it can better serve people in developing countries, and USDT can be used by people in Asia, Africa, and Latin America.

As for the issues of asset reserve that are criticized by most people, Tether has publicly responded in their reserves reports. Tether has been asking third-party agencies S&P Global Ratings, MOoDy’s, and Fitch Ratings Fitch to conduct full audits. Rumor mongers need to take a good look at Tether’s public reports.

However, concerns about USDT in the market are not completely a bad thing. It gives other stablecoins the opportunity to be adopted, such as USDC issued by Circle and DAI issued by MakerDAO. Although USDT is still the most widely used stablecoin, the market now has more diversity to offer. For investors, the ability to diversify their portfolio can help reduce the risks of losses from de-peggings.