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USDT Minting and Redemptions

Traditionally, to create a USDT, an entity must first make a US dollar deposit to Tether Limited, the company that operates the stablecoin. Per Tether Limited’s FAQs, USDT digital tokens “are 100% backed by Tether’s reserves” as can be seen on their website via a Transparency page. However, after Tether released a self-audit report in Q2 2021 as part of their agreement in a lawsuit with the NY Attorney General, it is now publicly known that this claim is false. Per the report, 75% of Tether reserves are backed by "cash and cash equivalent" which is discussed further in later sections.

USDT isn’t built on a particular blockchain network but rather exists as a dollar-equivalent across many platforms, including Omni (Bitcoin), Liquid (Bitcoin), Ethereum, Tron, EOS, Solana, Algorand, and more. Per a report from Protos, the following chart illustrates where the USDT minted between 2014 to Q3 2021 ended up. 

This section will focus on the most popular form of USDT released on Ethereum. Ethereum enables anyone to issue assets that abide by their ERC-20 token standard which allowed for seamless integration of USDT. Ethereum utilizes a modified version of Nakamoto consensus that yields roughly 10-15 transactions per second with a block time of roughly 12 seconds. For more on Ethereum, see our core report here or our abridged version here.

Stablecoins have exploded in transferring value on Ethereum as decentralized finance, or DeFi, has captured attention and because of this USDT issuance has 10x since 2020. As a dollar instrument on decentralized apps, USDT has served useful as collateral, in trading pairs, and as an effective arbitrage tool across decentralized exchanges. However, the mass volume of transactions due to this surge in activity has congested Ethereum’s network and increased transaction fees for users. This has hurt retail users’ ability to transact trivial amounts of ETH or stablecoins on the network.

In order to scale the Ethereum network and maintain this level of USDT value transfer, Ethereum enthusiasts are looking to techniques such as sharding or rollups. In the simplest terms, sharding would partition the ledger and computing components of Ethereum’s network and spread them across differing shards designated to a certain piece. Alternatively, rollups are a form of layer-two off-chain scaling technique similar to Bitcoin’s Lightning network.

USDT transfers aren’t inherently private, yet users may take specific measures to obscure their transactions. For example, transactions on public blockchains are broadcast to all network participants; therefore, USDT transfers on Ethereum, Tron, etc. are uniquely identifiable. That being said, blockchains represent and publish the ownership of tokens through addresses that correspond to digital wallets rather than a name, social security number, or location. While these general cryptocurrency transactions are often considered “pseudo-anonymous,” the increase in forensic blockchain companies and the propensity for wallet companies to comply with KYC/AML law diminish any assurance of privacy. However, in 2020, $15 million worth of USDT was transferred from Ethereum to Liquid, Bitcoin’s federated sidechain, which opened the door for private USDT transactions. Liquid as a federated sidechain, as opposed to a public blockchain, doesn’t broadcast transactions to all of Bitcoin’s network participants and rather enables confidential transactions. While Liquid is more centralized than public blockchains, transactions aren’t transparent, meaning users may transfer USDT to an exchange with the intent to buy tokens without market participants being aware. 

Maintaining the Dollar Peg

Hong Kong-based Tether Ltd. is the only entity capable of altering the supply of USDT. Given USDT is a currency intended to reflect the price of USD on public blockchains, the stablecoin is meant to be backed 1:1 by Tether Limited in reserves. In turn, Tether purports they accept fiat currency into a bank account and credit a corresponding user with new supply of USDT. Conversely, Tether Limited burns supply when users deposit USDT and redeem fiat currency to a bank account. 

The value of USDT rarely trades at exactly $1 but rather fluctuates around its one-to-one reserve ratio between the token (Tether) and its associated traditional fiat assets (e.g. US dollar bank deposits). However, arbitrageurs have a financial incentive to mitigate any fluctuations by redeeming/purchasing USDT whenever economically profitable.

The redemption mechanism of Tether is unique compared to other crypto assets. Tether holders can redeem their USDT for USD, but the minimum fiat withdrawal value is $100,000, and a KYC procedure must be followed. When the price of Tether goes below $1, there is an incentive to purchase it below the $1 peg and redeem it for the full $1. However, this is dependent upon having greater than $100,000 to redeem.

Once issued, a USDT token can be transferred, stored, and spent like any other cryptocurrency. Tether can be traded for other tokens at exchanges or withdrawn and held in any compatible wallet where the user controls their private keys. Tether Limited generates revenue from imposing a small fee on the issuance of new tokens.

Ultimately, the incentives for crypto entities (exchanges, funds, institutional traders) to mint or buy USDT are similar to the incentives for fiat entities to buy dollars — they’re both highly liquid. In crypto, most assets have trading pairs with sufficient depth in terms of USDT — just as worldwide assets have with dollars. Being perhaps the most liquid asset in crypto that mimics the most common money in the fiat world results in USDT being a quality medium of exchange and unit of account in crypto.