USDT (Tether) is the biggest cryptocurrency of its kind.
It is also the third-biggest cryptocurrency by market cap overall, just behind Bitcoin and Ethereum.
But USDT is really quite different from these coins.
That is because it was designed for an entirely different purpose - to act as something called a stablecoin....
So, you’re probably wondering, What is a Stablecoin?
If you’ve delved into the world of cryptocurrencies, you probably know they are extremely unstable and volatile.
It’s no secret that prices can rocket one week, only to plummet the next!
In this sense, it can be difficult to use these cryptocurrencies as a medium of payment...
This is where the concept of stablecoins was born.
You probably won’t be surprised that they’re exactly what they sound like.
While being cryptocurrencies, the way Ethereum is, they differ in that they hold a stable value.
This is because stablecoins are pegged to the value of their specific fiat currency pair.
USDT, for example, is pegged to the value of the US dollar.
Regardless of market volatility, stablecoins are designed to maintain their value on a 1 to 1 ratio with their peg.
But it begs the question - how do stablecoins like USDT remain so stable?
Well, it turns out that there is more than just one way that they do it…
Let’s explore the different types of Stablecoins
There are two main types of stablecoins, classified by how they work.
The first are coins like USDT, which are known as collateralized stablecoins.
I will cover these coins in more detail shortly.
The second type of stablecoins are known as algorithmic.
Algorithmic stablecoins are software-based, using programming to balance supply and demand in order to stabilize their value.
DAI is a good example of a functional algorithmic stablecoin.
A more infamous example of algorithmic stablecoins, however, would be Terra USD or UST, which crashed in May 2022.
Terra's USD crash is a significant event in recent crypto history, and is closely tied to the history of stablecoins.
And since we’re mentioning history…
How did USDT Get Started?
Around the start of 2012, there was an idea to use the Bitcoin blockchain as a base layer for new cryptocurrencies.
This idea further culminated in a project called Mastercoin, launching in July 2013.
Mastercoin is now known by a different name, the Omni Layer.
By 2014, employees from Mastercoin launched their own separate platform called Realcoin, which was soon renamed to Tether, the platform I’m discussing today.
It was the first blockchain-based platform to link real fiat currencies into the digital realm.
In the beginning, Tether exclusively used the Bitcoin blockchain as the base layer, which meant that most USDT coins were based on Bitcoin.
However, since the Bitcoin ecosystem has never had the most efficient or cost-effective blockchain, USDT (Tether) soon launched on other blockchains as well.
These included Ethereum, Solana, and Tron, among many others.
Fast forward to today, and most people are using the Ethereum-based version of Tether USDT.
After being listed on the BitFinex exchange in early 2015, USDT first passed the 1 billion token supply milestone in December 2017.
Three years later, USDT hit $20 billion in market capitalization.
By May 2023, USDT had crossed an incredible $80 billion in market cap.
This feat represents around 80 times growth in just five and a half years from the end of 2017 to mid-2023.
Clearly, USDT grew very quickly, which must mean it offers unique value to its users and investors, right?
But how does it all work?
Moving on, How does USDT work?
As mentioned before, USDT operates as a collateralized stablecoin.
It means that the coin is supported by real-world assets, such as cash, to maintain its peg to the US dollar.
Here is a simplified explanation.
When state banks print money, they take an asset, like gold, put it in their reserve, and hit the presses.
Without the gold backing the paper, the money has nothing to support its perceived value.
Tether aims to use a similar process.
Instead of gold, Tether takes US currency, keeping it in its treasury, before creating USDT tokens equal to their value.
It’s the funds in reserve which act as collateral, on a 1 to 1 ratio.
In this way, Tether should have reserves worth at least as much as the total value of USDT tokens in circulation.
However, things are not as straightforward as simply topping up their reserve bank account.
The reason for the complexity is because Tether's current reserves are not just made up of cash.
They can also contain cash equivalents, meaning the reserves can include loans or other financial assets on their books.
Surprisingly, it is worth noting that USDT's reserves are not audited, so it isn’t possible to work out the exact breakdown of Tether's USDT reserves.
This is one of USDT's potential weaknesses that I will discuss in a bit more detail later.
But it’s not all doom and gloom…
Let's talk about some of USDT's Strengths
The first and biggest strength of USDT is its sheer size and momentum.
USDT has a massive first-mover advantage and is the de facto stablecoin in use for the vast majority of the crypto space.
Around the time of this article, USDT's market cap was more than three times as big as USDC's, the second biggest stablecoin after USDT.
It is also almost 16 times as big as the third-biggest stablecoin, DAI.
This puts USDT squarely in a dominant position.
It is also why USDT is the easiest coin to use when you want to buy regular cryptocurrencies.
The second biggest strength of USDT is that it is supposed to be backed up by real assets and generally remains quite stable.
This is important for USDT, especially considering the market's ongoing skepticism of algorithmic stablecoins following the Terra USD or UST crash in 2022.
This is not to say that all algorithmic coins are bound to crash, but the sentiment remains.
So Tether USDT has generally remained stable regarding its peg to the US dollar.
Even on the rare occasions that it was not perfectly aligned, its price difference remained within 3% of its target $1 value.
Tether actually made a statement about it, accounting for occasional instability being due to external markets rather than the system itself.
While that covers some advantages of USDT, can it all be good news?
So, what are some of USDT’s weaknesses?
The most obvious chink in USDT's armor is that its reserves are not fully audited on a regular basis.
It means that nobody knows for sure if enough real-world assets actually back up USDT as they should.
Accordingly, this leaves room for speculation about USDT’s validity.
It’s also led to some critics accusing Tether of printing coins out of thin air, completely against what USDT is supposed to stand for.
Despite adequate opportunity for clarification, Tether has yet to give a definitive answer to this accusation or allow a thorough third-party audit of its reserves.
It’s this lack of transparency that could become USDT's Achilles' heel in the long term, causing the market to switch to a more trustworthy alternative.
And people have other reasons to be concerned about USDT, particularly considering its history.
For instance, Tether was hacked back in 2017, with the perpetrators making off with around $31 million worth of assets.
In turn, Tether had to implement a hard fork in order to try and stop the stolen funds from spreading to the larger ecosystem—not a good look!
Finally, Tether has also been embroiled in controversy because of its connection with the Bitfinex exchange.
Tether and Bitfinex are both iFinix's subsidiaries, making them related entities with a higher suspected probability of collusion.
In 2019, for instance, the New York Attorney General's office accused Bitfinex of covering up a loss of $850 million using funds from Tether.
The core of the accusation revolved around Tether allegedly transferring USDT to Bitfinex without clearly disclosing the transaction.
In the wake of these allegations, Tether revealed its reserves did not consist entirely of cash equivalents and may also include loan assets.
This statement implied that Tether's funds' transfer to Bitfinex was a loan, which in itself is also highly irregular.
Conclusion
In this article, you learned that USDT is the biggest stablecoin available in the market.
I also showed you how stablecoins are pegged to the value of their fiat currency in one of two ways: algorithms and collateral.
USDT works by being supported by collateralized assets like cash and cash equivalents.
Even though USDT is the most prominent stablecoin, there are still some concerns about the validity of its reserves.
The relationship with Bitfinex has also been a matter of controversy.
Ultimately, although USDT has some big concerns it should address, it is still the dominant stablecoin in the space, with a considerable lead over its competition.
It is also the most easily accessible medium of payment in the crypto space.
Since it has survived all these years, it will probably survive, if not thrive, in the future as well.
Well, that's it for this one. I hope you learned something useful!
