What’s up with Tether?

It has been fascinating to watch Tether over the years. Let’s start with the obvious, Tether is a bad product. Claiming that the token is backed by something (dollars in Tether’s case) without any mechanism of demonstrating this link, without transparency in the token’s supply, and without an open token creation and redemption process is a big problem. It would never work for any sophisticated or institutional investor.

But with all its problems Tethers utility is obvious. Take a look at coinmarketcap.com where BTC and ETH on average trade about 3% of their market cap a day, and USDT routinely trades above 100% of its market cap. The utility of this coin is not it’s “stability” but it’s presumed equality to a dollar. It is a dollar surrogate. Many exchanges avoid dealing with US dollar directly, instead, they use USDT as a substitute.

Over the last few days, Tether’s peg to the dollar has been challenged. Here’s an article on Cointelegraph that explains nicely what could have caused this diversion: https://cointelegraph.com/news/untethered-the-history-of-stablecoin-tether-and-how-it-has-lost-its-1-peg

Anybody who has an account on one of the exchanges that are using Tether should be concerned. If your money sitting in USDT and this “stable coin” is down 4% what should you do? Take a look at the image below, this is our aggregated BTC book with prices from all of the exchanges where we trade.

RFO Capital Aggregated BTCUSD Book

The first thing that people will notice is the 4.1% price inversion. We can buy BTC on Coinbase (GDAX) for 6428.06 and sell it on HitBTC for 6715.52. This inversion has been there for a last couple of days. What’s the cause of this inversion? Tether! You can clearly see a group of exchanges where Bitcoin prices are in 6700 range and another group of exchanges where prices are in 6400 range, the difference is the base currency in these pairs. Exchanges that show prices around 6700 trade BTC against USDT and exchanges where Bitcoin trades against the real dollar are showing prices around 6400. So this discrepancy is not really an arbitrage opportunity, it is the cost of USDT in USD.

Here’s the really difficult question, what would happen if USDT fails? What is the probability of that and if Tether collapses and what would happen with the Bitcoin and the rest of the coins? What would happen to the exchanges that use USDT? What would happen if there is a run on this token similar to a run on the currency? Let’s go through a hypothetical: if crypto traders lose confidence in USDT and start abandoning it, it will drive it’s price further and further down, as a self-fulfilling prophecy. Similar to how people sell risky assets and buy US dollar when there is a financial or political turmoil. People will sell USDT looking for safe haven. There are really only two suitable options: The Bitcoin or US Dollar.

If USDT collapses, an optimistic scenario would be for trades to sell out of USDT and buy Bitcoin as the most liquid coin. Then exchanges could find a replacement for Tether (another “stable coin” linked to US dollar) and, happy days, business would continue as usual.

I think the reality would be a lot darker. I think it would be a problem many times bigger than hacking of the MtGox. MtGox was a small problem, very few people knew anything about Bitcoin at the time, even fewer people had accounts there, so the problem was confined to that circle of crypto geeks. Now the problems would be a lot bigger with many Main Street investors trading cryptocurrencies.

I think if Tether collapses, it would bring a nuclear winter into the already depressed crypto market. I am not even sure the market would recover, not any time soon. Traders will lose confidence in the existing trading models, investors will lose money. And I think the prices of all coins, including Bitcoin will collapse.

So that’s the bad news, but here’s a good news. I don’t think exchanges will allow this scenario to happen. Binance and other exchanges are making too much money to allow Tether to collapse and to threaten their businesses. Even if the entire 2.1 billion USD is missing, top exchanges can work together to create an emergency fund to support it. Tether’s value is based on the confidence that market participants put into it. Exchanges could provide the support needed to maintain the 1-to-1 peg for the USDT and restore the confidence in this product. Already Tether price after falling to 96 cents recovered to 98 cents. So this confidence restoration project maybe already underway.

I think Tether will survive, for now. Long term it is still a problem and there are many projects in the works looking to replace it. Top market participants see the problem and risk that Tether represents, and the process of getting rid of USDT may have started already, Tether market cap is down from 2.7 to 2.1 billion. The biggest drop in its short history.

My long-term prediction is that Tether will be replaced by a safe and transparent alternative. Alternative where the underlying asset can be audited, where the token creation and redemption process is transparent, where the peg is naturally maintained and doesn’t need any resources to be protected. The design of such token is not difficult to imagine. There are many projects that have such dollar-backed tokens, Fungible Network also has a dollar-backed token design. We can issue it if we find the right partners. But for now I am watching the show called Tether, it has intrigue, suspense, and a little tragedy, I hope it ends well.

Disclosure: I am holding a very small balance of USDT.

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Dan Raykhman, CEO of Fungible Network

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Father, husband, entrepreneur, skeptic. As the Internet liberated information, crypto will liberate capital. World will be tokenized one asset at a time!