News recently broke that Coinbase will list the Tether (USDT) on its CoinbasePro trading platform. Users will be able to deposit USDT starting later this month. This is the latest, in a long line of developments, that have served to legitimize USDT. Prior to the start of 2021, USDT was hampered by accusations of legal issues, false minting of USDT, fractional reserve practices, and more. This "reputation issue" contributed to the West's apprehension to USDT adoption (USDT is very popular in Asia). However, in the span of 6 months, Tether has reached a positive resolution with its NYAG case, provided a favorable audit report attesting to full-proof of reserves, and has now been included into the West's largest and legally compliant exchange, Coinbase. Talk about a good run!
Even with all the good news, risks still remain. It's important to understand the whole picture. So, let's take a look at the latest new from Tether concerning their financial situation. For the first time in 6 years, Tether released some inside information concerning their cash reserves. According to Tether, they hold 76% of their reserves in "cash and cash equivalents" while the other 24% are held in secured loans, bonds, bitcoin, and others. So, what to make of this news? Well, it isn't that much different than what we already expected and what surfaced during their NY Attorney General case. On one hand, the company used to openly purport that every USDT had a dollar backing it. As the years, lawsuits, and now this report prove, that's just false. The company lied.
However, they seem to be handling their assets and risk management well because USDT has exploded in growth to nearly $60B and has remained stable this entire time over the years.
So as our report discusses below, Tether operates in a black box that requires trust, totally antithetical to the whole idea of cryptocurrencies. The company has been proven to misrepresent their assets and certainly walks a fine regulatory line. On the other hand, it is the longest, "stablest", most liquid cryptodollar on the market. Each user just has to decided what their comfortable with. Decide for yourself whether the risks are worth the rewards.
Formerly known as RealCoin, US Dollar Tether (USDT) was established in 2014, making it one of the oldest stablecoins. USDT is a cryptocurrency that leverages distributed ledger technology to allow individuals and organizations to store, send, and receive digital tokens pegged primarily to US dollars (USDT), but also euros (EURT), the Chinese yuan (CNHT), and gold (XAUT). Tether tokens can be quickly sent and received in peer-to-peer fashion over multiple blockchains across the globe and for a fraction of the transaction costs of many legacy payment networks.
- Liquidity and market dominance: USDT is one of the longest-running stablecoin with the most liquidity and exchange listings. Its network effects have given it a sizable lead in the stablecoin market with nearly 70% dominance.
- Price stability and track record: USDT has a significantly longer history of (almost) perfectly holding its dollar peg, thereby earning the trust of many traders.
- Exchange listings: Tether is supported by nearly all exchanges including many of the largest and most trusted.
- Centralized project with an unscrupulous team : Counter to the cryptocurrency ethos, USDT is completely centralized around one company and asks that its user completely trust this single-point of failure. Additionally, the company has already been exposed as lying about its “one-to-one US dollar backing.”
- Lack of transparency and audits: Tether’s minting process and auditing practices operate in a “black box” with little transparency.
- Unclear banking relations and regulatory status: Tether Limited, over the course of its existence, has jumped from one banking partner and regulatory jurisdiction to another, raising concerns over the project’s legitimacy and legal standing.
- Counterparty risk: Tether Limited is on record as stating that holding Tethers provides no legally enforceable rights to a US dollar for the holder. Users are also reliant on Tether’s relationships with banks outside of the high standards enforced in the US.
Tether (USDT) is a currency that represents the price of US dollars on public blockchains. It’s commonly known as a “stablecoin,” a digital currency anchored to the price of an underlying asset (Ex: US dollars, euros, yuan, gold), redeemable 1-for-1 with the underlying currency. Each USDT is an IOU issued by Tether Limited, which entitles users to dollar deposits at Deltec bank in the Bahamas.
USDT, formerly known as “RealCoin,” was released in 2014 as one of the earliest stablecoins created, and today is the most widely used. All coins are issued by associated company Tether Limited which notably has the same founders as Hong Kong-based exchange Bitfinex. It’s become blockchain-agnostic having been deployed on nine public blockchains including Algorand, EOS, Ethereum, Bitcoin (Liquid & Omni), Bitcoin Cash, Tron, OMG Network, and most recently, layer-one Ethereum competitor Solana.
USDT benefits holders as a dollar-denominated bearer asset whereby possession is described by a private key that can permit a spend without depending on a third-party. Its transactions are auditable by anyone on publicly accessible blockchains, and the price stability garnered from the price of US dollars enables traders to mitigate volatility risk in the greater cryptoasset market. Further, a dollar-peg enables USDT as a functional form of collateral in crypto-finance along with opening arbitrage opportunities where asset prices differ across exchanges.
Overall, USDT mitigates volatility risk in the overall cryptocurrency market, diversifies protocol risk among varying cryptocurrency projects, and reduces exchange risk without relying on a single exchange. Additionally, it benefits from the cryptographic assurances of assets recorded on public blockchains and held in digital wallets.
As a stablecoin, USDT inherits the benefits of being built upon crypto-native infrastructure compared to presiding within the legacy financial system. It can be sent 24/7/365, with a speedy settlement across borders directly to an individuals’, exchanges’, or merchants’ digital wallet.
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, there remains uncertainty around the veracity of these claims (discussed further in the Vulnerabilities section).
Since USDT isn’t built on a particular blockchain network and rather exists as a dollar-equivalent across many platforms, it is constrained by the technology of each chain on which it transacts. It’s become blockchain-agnostic having been deployed on nine public blockchains including Algorand, EOS, Ethereum, Bitcoin (Liquid & Omni), Bitcoin Cash, Tron, OMG Network, and most recently, layer-one Ethereum competitor Solana.
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.
In 2019, stablecoin value overtook the transfer value of ETH on Ethereum with USDT leading the way.
Overall, USDT is dependent on the assurances of the blockchain network in which it's being transacted. However, it is fault-tolerant as it exists on many different chains while also benefiting from infrastructure superior to the legacy financial system. Although USDT is centralized in a monetary policy sense, it is resilient in a technological sense.
According to USDT’s whitepaper, Tether Limited is responsible for:
- Accepting fiat deposits and issuing corresponding Tethers
- Sending fiat withdrawals and revoking corresponding Tethers
- Custodying fiat reserves that back all Tethers in circulation
- Publicly reporting Proof of Reserves and audit results
- Initiating and managing integrations with existing blockchain wallets, exchanges, and merchants
- Operating a web wallet that allows users to send, receive, store, and convert Tether conveniently
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. 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 August 2020, Tether passed a major milestone in its existence as its 7-day average adjusted transfer value finally flipped Bitcoin’s, reaching over $3.55 billion compared to Bitcoin’s $2.94 billion. This flip signaled a monumental change in the crypto-industry as Bitcoin had been the default reserve asset and base trading pair since its creation in 2009. Tether now holds that distinction and continues to take more and more of the market share of on-chain transfers.
Tether surpassed bitcoin in daily transfer value.
The supply figures of USDT are dynamic depending on the demand from users. For example, the free float supply of USDT (TRC20 & ERC-20) grew from around 10 million in January 2017 to over 2.8 billion in September 2018. Further, in 2020, the free float supply of USDT grew from around 3.9 billion in January to 60 billion in May 2021 . Prior to March 2020 it had taken over three years for total supply to grow to about 6 billion.
Governance is a controversial aspect of Tether as leaked documents and investigative journalists have debunked some of the company’s claims. With that said, Tether Limited is the minting agency that controls the supply and development of USDT. They claim to be fully reserved (maintain a 1:1 backing) and mint/burn USDT as real fiat dollars are deposited/withdrawn from their reserves.
In 2015, popular exchange Bitfinex enabled trading of USDT on their platform without indicating any further relationship with Tether Limited. However, the Paradise Papers leak in 2017 revealed Bitfinex operators Phillip Potter and Giancarlo Devasini were responsible for setting up Tether Holdings Limited, the parent company of Tether Limited, in the British Virgin Islands in 2014. Additionally, a later investigation proved the two firms to have a common CEO, JL (Jean-Louis) van der Velde.
Outside of the centralized issuing entity, USDT is available on many public blockchains, and as a result, protocol risk is idiosyncratic to each transport network.
Ultimately, Tether is a centralized bank-like entity where businesses and individuals undergo a KYC verification process to ostensibly deposit and redeem USDT. While users are subject to the centralization risk of this issuing entity, USDT transacted peer-to-peer or with an exchange is outside the scope of Tether’s KYC process and is subject to risks associated with the transacting counterparty and transport protocol. Given the inconsistent claims of Tether Limited and centralized control over its issuance, USDT owners must weigh these risks when deciding whether it is worth holding and transacting in USDT.
Additionally, in November 2018, the New York Attorney General issued subpoenas to Bitfinex and Tether which, as discussed above, are owned and operated by the same small group of individuals. According to the filings, Bitfinex has siphoned at least $700 million from Tether’s reserves; the Attorney general describes these transactions as “treat[ing] Tether’s cash reserves as Bitfinex’s corporate slush fund.” Given this example and the connection between these two companies, USDT’s centralization risk is clear and subject to a small group of leaders.
However, some clarity/a conclusion was reached in February 2021 when Tether and Bitfinex reached a settlement with the New York Attorney General’s Office. Under the terms of the settlement, Tether did not have to admit any wrongdoing but did pay an $18.5 million fine. The investigation took over two and a half years and for Tether to come out of the matter with only a small fine can only be viewed as a win for the project. The settlement resolved the allegations about the $850 million loan Tether made to Bitfinex when Bitfinex was having issues accessing funds. The loan was repaid early and in full, including interest. At no point did the loan impact Tether’s ability to process redemptions.
The largest outstanding risks associated with Tether aren’t technological — they are rather financial, legal, security, and censorship risks.
It’s been reported Tether Limited hasn’t had consistent banking relationships throughout its lifetime. Tether is limited or restricted for use in the following areas: Cuba, North Korea, Iran, Pakistan, Syria, Venezuela, Crimea, and the US. The financial viability of Tether Limited connecting to US banking institutions is a serious and legitimate threat to USDT.
Additionally, the very idea of stablecoins or “crypto dollars” have come under attack from US regulators as the STABLE Act was proposed in December 2020. The STABLE Act was written with “the intent to prevent abuse, opacity, and the potential rise of a stablecoin-based shadow-banking system.” However, the obligations that stablecoin issuers would have to abide by in order to avoid breaking the law are incredibly cumbersome and/or restrictive.
Any stablecoin issuer would be required to obtain a federal banking charter and required to obtain the approval of both the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) six months before issuance. Additionally, the stablecoin issuers would either need to obtain FDIC insurance or deposit dollar reserves directly at the Federal Reserve.
In November 2017, roughly $31 million were stolen from Tether. Notably, as Tether Limited isn’t a US-regulated bank, users are outside the promise of FDIC-insured bank accounts that guarantee withdrawals up to a threshold of dollars. Ultimately, as a centralized entity, users must trust Tether Limited to responsibly custody deposits.
USDT hasn’t always reflected fully-backed dollar reserves or a dollar-pegged value. Despite a solvency report released to the public in 2017 which indicated a fully-backed USDT supply, a roughly 74% backing was revealed by Tether’s General Counsel in a 2019 Supreme Court hearing in New York. Also, Tether's stability mechanism to maintain a dollar peg is imperfect, as USDT was trading at a ten percent discount in 2018 across notable exchanges Kraken and Bittrex.
Lastly, Tether’s history of blacklisting addresses, freezing funds, and complying with regulatory pressures pose remarkable censorship risks. In 2020 alone, 84 addresses have been blacklisted, meaning the funds held by these wallets are completely unusable.
Overall, USDT is vulnerable to financial, legal, and security risk. Tether Limited has proven its inability to maintain a relationship with a US depository institution while also revealing its lack of regulatory compliance, protection of reserves, solvency, and ability to be honest in its transparency reports.