The 2022 cryptocurrency market has been a ruthless bloodbath — one of the deepest periods of fear and realized losses recorded in the history of crypto. The majority of retail investors have capitulated out of the market, many of whom with a fraction of what they had initially invested during the bull run.
The crypto market has caught up with the bankruptcy of FTX — a previously world-class centralized crypto exchange (CEX). FTX owes over $3 billion to its top 50 largest creditors alone, out of the almost one million total creditors in the FTX ecosystem.
While the consequences of the FTX collapse are undoubtedly severe and bleak, they pale in comparison to the fallout of another supposedly ticking time bomb in the cryptocurrency space — Tether (USDT). The following discussion will assess whether USDT is safe and the key risks associated with USDT.
What is USDT?
USDT is a popular stablecoin in the cryptocurrency sector. However, before delving into the intricacies of USDT, it is important to first understand what stablecoins are and how they work.
What is a Stablecoin?
Stablecoins are digital currencies whose value is tied to that of another asset — most often the U.S. dollar — and are designed to reduce the inherent volatility of cryptocurrencies. Stablecoins are primarily used to facilitate efficient and simple cryptocurrency trading, although they are increasingly used for payments within decentralized applications (dApps), remittances and settlement, among other use cases.
USDT is a unique example of fiat-collateralized stablecoins and is widely used in the cryptocurrency community. Unlike other types of stablecoin, fiat-collateralized stablecoins maintain a reserve of fiat currency (or currencies) such as the U.S. dollar to assure the stablecoin’s value. Fiat collateral remains in reserve with the central issuer and must reflect the number of corresponding stablecoins in circulation.
Fiat-collateralized stablecoins like USDT USDC are by far the most prevalent. However, algorithmic stablecoins such as DAI are rapidly gaining popularity.
USDT History
USDT, originally known as Realcoin, was founded in July 2014. USDT was created as an attempt to solve two significant issues with existing cryptocurrencies — the high volatility of cryptocurrencies and a lack of convertibility between cryptocurrencies and fiat currencies. Tether is closely linked to the crypto exchange Bitfinex as it shares the same parent company, iFinex.
Tether started out as a fully backed by 1:1 deposits of U.S. dollars held at banks. It is predominantly used on the Ethereum blockchain. On Ethereum, USDT tokens are represented as ERC-20 tokens. It can also be used with the Bitcoin blockchain through the innovative Omni layer.
Since inception, Tether has been in the spotlight for multiple controversies (for good reason), such as its false claims pertaining to the composition of its reserves backing USDT. It claimed it was still backed by USD 1:1 long after that was no longer the case. Despite the controversies, Tether has still managed to gain the trust of the mainstream. As of November 2022, Tether is the largest stablecoin in the world.
How is USDT Backed?
In March 2019, Tether updated its disclosure statement claiming that its tokens are no longer backed by 100% U.S. dollar deposits. Instead, Tether now claims that it is backed by 100% reserves, which include traditional currency, cash equivalents and other receivables and assets from loans made by Tether to third parties.
According to Tether, the reserve serves as a guarantee that if everyone wanted to convert USDT into fiat, they could. According to its latest report, Tether’s reserve contains a diverse mix of:
- Cash
- Cash equivalents (money market funds, U.S. Treasury bills)
- Corporate bonds
- Commercial paper
- Loans
- Other investments including digital currencies
The most controversy surrounding USDT’s reserves has been around the non-cash holdings, including what they are, how they are valued and how easily Tether can convert them into cash if stablecoin holders wanted to exchange their initial investment at once. In Tether's first report detailing its reserves, it revealed that commercial paper made up more than 40% of its reserves. This was scary for because commercial paper is an often extremely risky kind of non-collateralized debt. Luckily, it has since claimed that it has significantly decreased the percentage of its reserves made up of commercial paper. This doesn't mean USDT is entirely safe, however.
Is USDT Safe?
While USDT is supported by cash and cash-like assets, as demonstrated by Tether’s latest report, key risks are associated with USDT. These risks are described below.
Centralized Project
Counter to the cryptocurrency ethos of decentralization, USDT is centralized around one company that asks its users to put trust in a single point of failure. The company has also been exposed as lying about its one-to-one U.S. dollar backing.
In February 2022, after a 22-month inquiry, the New York Attorney General reached a settlement with iFinex, the parent company of Tether and the crypto exchange Bitfinex. Investigators accused the companies of unlawfully hiding losses. Attorney General Letitia James stated, “Tether’s claims that its virtual currency was fully backed by U.S. dollars at all times was a lie.”
As a result of this misdemeanor, iFinex had to pay an $18.5 million fine and is no longer allowed to operate in New York. Also, it will have to provide quarterly reports on its reserves. The company denies any wrongdoing despite the overwhelming evidence indicating otherwise.
If Tether Fails, It Could Tear Down the Entire Crypto Industry
To understand the significance of USDT collapsing, it is important to understand the prevalence of USDT in the crypto ecosystem. USDT is the largest stablecoin by market capitalization and the third-largest cryptocurrency in the world. It makes up 85% of Bitcoin’s volume — with it gone, Bitcoin would fall to around $5,000 again.
Rohan Grey, an assistant law professor at the Willamette University College of Law, told the Financial Times, "The growing world of stablecoins arguably underpins the entire crypto community right now. If that collapses, the whole space could collapse."
Unclear Banking Regulations, Regulatory Status and Auditing Practices
Tether has jumped from one banking partner and regulatory jurisdiction to another over the course of its existence. This practice has raised concerns over the project’s legitimacy and future legal standing.
The process by which new USDT is minted and auditing practices operate in a black box with limited transparency.
USDT Alternatives
Although USDT is the most popular stablecoin in the market, several robust alternatives are available. Some of the ways they differ depend on the issuer entity, how they keep their prices pegged to the fiat currency and the collateral that backs the value. Here are a few of the most promising stablecoins in the market.
USDC
USDC, also referred to as USD coin, is a leading fiat-collateralized stablecoin. USDC was established by Circle in 2018 and is pegged at 1:1 with the U.S. dollar. Unlike USDT, USDC’s reserves have more weighting towards cash and cash equivalents. Unlike USDT, of which Tether is the only issuer, USDC can be issued and redeemed by other member institutions of the CENTRE Network, such as Coinbase.
USDC trails USDT as the fourth-largest cryptocurrency in the world and the second-largest stablecoin by market capitalization. While USDC has a lower trading volume, it is widely regarded as a safer store of value since it's backed by more cash and cash equivalents. However, like USDT, USDC is subject to the same risks associated with centralization and counters the core ethos of cryptocurrency.
BUSD
Like USDC and USDT, BUSD is a fiat-backed, regulated stablecoin pegged to the U.S. dollar. For every unit of BUSD, there is one U.S. dollar held in reserve. In other words, the supply of BUSD is pegged to the U.S. dollar at a 1:1 ratio.
BUSD was founded by Paxos and Binance. As a result, BUSD is widely used across multiple trading pairs on the Binance exchange. Paxos uses blockchain technology to offer its stablecoin as a service to external companies. The New York State Department of Financial Services regulates BUSD. It is important to note that BUSD is one of the only stablecoins that is verified by financial institutions and audited by international accounting firms.
DAI
DAI is a decentralized stablecoin built by the MakerDAO platform, operating on the Ethereum blockchain. It aims to maintain a stable 1:1 value against the U.S. dollar without the need for a central authority through the use of smart contracts. Since DAI is stored on the Ethereum blockchain, it can easily be stored or transferred directly to anyone anywhere in the world without going through third parties such as banks.
DAI maintains its value not by being backed by U.S. dollars but by multiple cryptocurrencies, with Ether (ETH) being the primary form of collateralization. The value of ETH used is designed to exceed the value of DAI issued to you (referred to as over-collateralization).
How to Buy Stablecoins
Major stablecoins such as USDT or USDC can be traded on all kinds of exchanges. Some of the best trading platform that offer stablecoins are eToro, Gemini, Crypto.com and Binance. Many of these platforms allow you to swap fiat currency for stablecoins using your credit card, through swapping features or through different trading pairs such as USD/USDT.
Cryptocurrency is offered by eToro USA LLC (“the MSB”) (NMLS: 1769299) and is not FDIC or SIPC insured. Investing involves risk
Don’t invest unless you’re prepared to lose all the money you invest. This is a high-risk investment and you should not expect to be protected if something goes wrong. Take 2 mins to learn more
So, Is Tether (USDT) Safe?
Overall, while USDT is a useful, efficient and widely used stablecoin in the cryptocurrency market, it is also controversial, and for good reason. Tether’s shaky track record, lack of transparency and limited cash or cash equivalent holdings make Tether a risky place to park capital. It is best practice to limit your long-term exposure to USDT and only keep what’s necessary for day-to-day or week-to-week trading obligations. However, USDT has massive reserves and it claims to have a large amount of cash, ready to match any withdrawals. This means that it would likely require a large bank-run to depeg USDT. So, USDT may be safe but it's likely not worth the risk whatsoever. Prudent investors will also diversify their stablecoin allocation to reduce the risk of one particular stablecoin collapsing and wiping out their entire portfolio.
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