What Is Tether? How Does It Work? (2024)

Tether (USDT) is the largest stablecoin by market capitalization. Crypto traders use stablecoins like Tether to make transfers between different cryptocurrencies or to move their investments into or out of fiat currencies.

The value of USDT is pegged to the U.S. dollar. In theory, this means Tether should be unaffected by the volatility that can so dramatically impact the values of other cryptocurrencies, like Bitcoin (BTC).

What Is A Stablecoin?

Stablecoins like Tether provide a low volatility digital asset that usually maintains a steady valuation. The value of a stablecoin is pegged to a stable asset like gold, the U.S. dollar or another fiat currency, which means the coin attempts to maintain the same value as its peg.

“The idea is that 1 Tether can always be traded for $1, regardless of market conditions,” says Steve Bumbera, the co-founder and lead developer of Many Worlds Token.

Presently Tether is the largest stablecoin, accounting for approximately 53% of the total stablecoin market capitalization. USD Coin (USDC) is the second largest stablecoin by market cap with around 31% of the market, followed by Binance USD (BUSD).

Crypto traders use stablecoins like Tether to provide steady, reliable liquidity to get in and out of cryptocurrency trades without facing unpredictable losses from volatile price changes.

Tether issues several other stablecoins backed by different assets, including:

• Tether Gold (AUXT)is pegged to the price of gold.
• Tether Euro (EURT)is pegged to the euro.
• Tether GBP (GBPT)is pegged to the U.K. pound.
• Tether Yuan (CNHT)is pegged to the Chinese yuan.

How Does Tether Work?

The stability of Tether comes from its currency reserves, as the company claims to hold dollars and other assets that are equal or greater than the total number of USDT in circulation. In other words, for every one Tether token in circulation, the company claims it owns one dollar in its reserves, either in cash or cash equivalents like short-term bonds or time deposits.

On its website, Tether publishes daily reports on the amount of reservers it holds versus the number of USDT tokens that are outstanding. There have been questions and controversies surrounding Tether’s reserves, including investigations by the Commodity Futures Trading Commission (CFTC) and the New York Attorney General regarding the company’s reserves.

Investors can buy Tether on most major crypto exchanges. When you purchase $100 in Tether, you would receive approximately 100 USDT tokens and the company would boost its reserves by $100 in order to maintain the 1-to-1 dollar peg. Tether tokens are destroyed and removed from circulation when users redeem the tokens for fiat currency.

Tether lacks its own dedicated blockchain, opting instead to offer tokens on third-party blockchains. USDT tokens are currently hosted on:

• Ethereum
• Tron
• Algorand
• Solana
• Avalanche
• Polygon

A Brief History of Tether

The roots of Tether date back a decade, to when J.R. Willet was looking to build new cryptocurrencies on the Bitcoin protocol. Willet implemented this idea with Mastercoin, and one of its original members would later become the co-founder of Tether in 2014.

Using Tether for liquidity began when it was added to the BitFinex exchange in January 2015.

Recent market turbulence, which saw the price of TerraUSD, another stablecoin pegged to the U.S. dollar, drop to less than $0.23, caused Tether to break its $1 peg. The decline was largely driven by investors’ fears that if one stablecoin can break its peg, others can, too.

“As an asset-backed stablecoin, with holdings primarily in U.S. Treasurys, [Tether] stands a far better chance of weathering the current tsunami rocking the digital asset world,” says Marc LoPresti, managing director of The Strategic Funds. He says the only stablecoin with comparable collateral quality is USD Coin.

Can You Trust Tether?

Stablecoins remain a popular choice among crypto traders, and Tether weathered controversies about liquidity and the adequacy of its reserves.

As recently as 2022, the company did not offer much clarity regarding its reserves. At one point, Tether’s website merely stated that “All Tether tokens are pegged at 1-to-1 with a matching fiat currency and are backed 100% by Tether’s reserves.”

Adam Carlton, CEO of crypto wallet Pink Panda, says Tether’s history of being transparent about how the coin is backed hasn’t always been clear or consistent.

“It has a very questionable legal past, and to this day, its actual reserves are still quite opaque and believed to be substantially composed of unknown sources of commercial paper,” Carlton says.

Other crypto experts say it’s somewhat accepted that Tether isn’t fully collateralized in the crypto marketplace.

“Markets have worked through that concept of how comfortable they are—it’s very clear Tether is not backed by dollars,” says James Putra, vice president of product strategy at TradeStation Crypto.

Tether and the TerraUSD Meltdown

TerraUSD (UST) is a U.S. dollar stablecoin that sparked a crisis in cryptocurrency markets in 2022. At that time, TerraUSD used an algorithm-based system to maintain its peg to the dollar instead of cash reserves. The collapse of this system is widely cited as one of the main causes of the ongoing crypto winter.

Relying on an algorithm rather than cash reserves caused TerraUSD to lose its price peg during a major liquidity crunch in early 2022. UST relied on a sister token called Luna plus a huge reserve of Bitcoin to back its 1-to-1 peg. Traders exploited the algorithm that used Luna to maintain the value of UST in order to make quick profits, and the entire system crashed over a matter of days.

“Owning 1 UST, you would expect to be able to cash out for $1 at any point, but it lost its peg,” Bumbera says.

The TerraUSD meltdown shocked the cryptocurrency market, which was already experiencing other difficulties at the time. The so-called Terra/Luna crash ended up driving down the price of Bitcoin, and it’s estimated that caused $300 billion in losses across the entire market.

Tether vs. Bitcoin

According to Daniel Rodriguez, chief operating officer at Hill Wealth Strategies, the key difference between TetherUSD and Bitcoin is that Tether is tied to a non-crypto asset, the U.S. dollar. Bitcoin is not tied to anything beyond the supply and demand for BTC.

In addition, Tether is a centralized cryptocurrency whereas Bitcoin is decentralized. In theory, this helps Tether remain more stable than Bitcoin.

Cryptocurrencies that are not pegged to a real-world asset or currency are subject to market volatility. Most traditional cryptocurrencies like Ethereum and Litecoin (LTC) will see extreme fluctuations and volatility with the market, inflation and interest rates.

“Tether seems to be a little more stable because it stays close to the value of one USD, give or take a few cents,” Rodriguez says. “Tether isn’t designed to necessarily make money but rather be a stable store of value.”

Is Tether a Good Investment?

Stablecoins like Tether don’t make much sense as an investment because they aren’t meant to increase in value. They only operate as a store of value, since one USDT should always equal one dollar.

Besides being a useful store of value, the benefit of Tether is as a tool for conducting business in a far simpler manner than using Bitcoin.

“One Bitcoin today will not be the same price of Bitcoin tomorrow, making it incredibly difficult to create pricing schemas for companies based solely on BTC,” says Bumbera.

One good reason to own a stablecoin such as USDT, Bumbera says, is if you want to keep your money in crypto but want to avoid volatility. But even staked to the U.S. dollar, Terra is far from a safe investment.

“The risk would be Tether losing its value or the staking platform chosen is not legitimate,” Bumbera says.

While the company purports that it “never once failed to honor a redemption request from any of its verified customers” to date, nothing in investing or cryptocurrencies is guaranteed.

Cryptocurrency users also need to be aware of the changing regulatory landscape around digital assets.

“The future of Tether and other stablecoins depends on transparency, (and the) sufficiency of collateral and liquidity,” LoPresti says. “These features will be the focus of regulators, who will undoubtedly focus their efforts on this sector of the digital asset economy due to the collapse of TerraUSD.”