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Is Tether a Threat to Bitcoin?

Posted 2/3/21 by Daniel Matuszewski

There has been a long-lasting concern that Bitcoin’s price appre­ci­a­tion is driven by the creation of an artifi­cial digital dollar called Tether.  This partic­ular piece of FUD (fear, uncer­tainty, doubt) appeals to the popular intuition that Bitcoin is little more than a Ponzi scheme.  Rather than dig deeper into questions like, “what is money?” and, “what makes good money?”, these critics lead with the answer they want and find circum­stan­tial evidence later.

However, it’s clear that Tether is not the driver of Bitcoin’s rallies. Rather, Tether’s growth is evidence of the very real demand for a digital dollar that arose naturally in the world’s first 247 global finan­cial marketplace. 

Why does Tether exist?

Tether origi­nated as a digital dollar on Bitfinex, one of the older and larger Bitcoin exchanges that operates primarily in Asia.  When a user deposited funds into their Bitfinex account, their dollars were deposited into the Bitfinex bank account and the user was credited with an equiv­a­lent amount in Tether they could use freely on the trading platform Impor­tantly, these Tethers, an unforge­able digital asset, can be removed from the Bitfinex platform and stored in an individual’s self-custodied cryptocur­rency wallet.

In essence, Tether was a way for Bitfinex to grant its users a bearer digital dollar that they could control themselves, gaining some of the digitized advan­tages of Bitcoin while remaining pegged to the U.S. Dollar’s value.

Why were so many created?

In 2017, the demand for Bitcoin and other cryptocur­ren­cies spiked world­wide.  But, it did not spike uniformly.  Because of variances in interest and access to trading venues, different parts of the world experi­enced the 2017 bull market in different ways.  In the United States, trading venues were flooded with demand for new accounts and hopelessly backlogged.  Coinbase was the largest and most estab­lished, and made it compar­a­tively easy to set up an account and buy without much delay.  As a result, a dispro­por­tionate amount of new demand funneled into Coinbase, bidding up the price of Bitcoin there. 

Other exchanges did not see such a stark influx of new demand.  Because Bitfinex had one of the slowest new customer onboarding and approval processes, it saw a compar­a­tively small spike in demand relative to Coinbase.  As a result, the price of Bitcoin on Coinbase was bid up to signif­i­cantly higher prices than on Bitfinex. 

Profes­sional traders who had already estab­lished accounts with higher limits on both platforms stepped in to take advan­tage of this arbitrage opportunity. 

These traders could sell Bitcoin on Coinbase at high prices and withdraw the dollar proceeds from their account.  Then, they could wire these dollars to Bitfinex, which would be posted to their Bitfinex account as Tether.  With their Bitfinex account funded, they could then buy Bitcoin at market prices lower than on Coinbase.  With these funds now converted to Bitcoin, they could send that Bitcoin from their Bitfinex account to their Coinbase account and sell at the higher market rates there.  This same process could be repeated over and over, cycling up to $20M per day (Coinbase’s highest withdrawal limit for profes­sional accounts).  Over the course of several months, profes­sional traders like Dan Matuszewski at Circle Trade deposited billions of dollars into Bitfinex through this mecha­nism, in turn creating billions of 1‑to‑1 digital Tethers.

Why have Tethers accumulated?

Tether’s utility is often overlooked: Tether is more useful to a digital asset trader than a dollar is.  Every time a dollar moves, it is subject to slow tradi­tional banking processes and scrutiny.  Traders looking to move funds between venues would rather transact with a digital dollar unencum­bered by tradi­tional banking rails.

Because of the greater utility of Tethers compared to actual dollars, there was ample demand to use them outside of Bitfinex.  Trading venues around the world responded to the demand by creating Bitcoin/Tether trading pairs and allowing users to deposit and withdraw Tethers. 

As a result, use of Tethers prolif­er­ated across digital asset markets.  With demand for Tethers exceeding users’ interest in redeeming them for dollars, the number of Tethers in circu­la­tion soared.

Was Tether creation driving Bitcoin’s price increases?

To a certain extent, Tether creation would be a leading indicator of demand for Bitcoin on Bitfinex, as users funding their accounts are creating new Tethers before they use them to bid for Bitcoin.  However, the bigger claim put forth by skeptics, unfamiliar with an old saying about corre­la­tion and causa­tion, is that Tether creation was the reason that Bitcoin’s price was going up in the first place.  Indeed, the number of Tether in circu­la­tion moves in lock-step with the price of Bitcoin during bull markets.  However, the reason­able expla­na­tion is that Tether creation is the lagging indicator: a byproduct of new dollars coming into the market. 

Is Tether’s continued growth evidence that it is a giant house of cards?

At this point in time, 20B Tethers are in circu­la­tion in the global digital asset market.  Tethers continue to be created at a rate faster than they are redeemed for dollars. Rather than evidence of some gigantic fraud, this continued growth is testa­ment to the utility of digital dollars. 

Beyond its superior transfer quali­ties, Tether has increas­ingly been adopted by global citizens who would like to hold dollars despite their national banking systems forbid­ding it.  For example, there is signif­i­cant demand in China for Tethers.  Despite the fact that they are simply promis­sory notes for dollars held in a company’s bank account, the demand for them is very real as a result of the restric­tions preventing individ­uals from holding real dollars. 

This demand is evidenced by the fact that Tether actually trades above its $1/Tether issuance rate.  Over the last year, Tether has traded on average at $1.0005/Tether, meaning a 5 bps premium.  It’s simple to see why the total number of Tethers in circu­la­tion keeps going up: the global market views them as more valuable than dollars because of their wider utility and access compared with dollars.

Isn’t Tether mired in legal controversy?

Tether is tied up in legal proceed­ings with the NY Attorney General’s office.  It is alleged that there was an improper loan of $850M from Tether to Bitfinex, allegedly made in order to cover for a loss of customer funds as a result of fraud by one of Bitfinex’s payment proces­sors, Crypto Capital. 

These accusa­tions are serious, but indepen­dent from the question of whether Tether themselves are properly collat­er­al­ized with bank account holdings.  Indeed, it’s worth noting the glaring lack of regula­tory action against Tether on this front, suggesting that author­i­ties do not have reason to believe that Tether has fraud­u­lently created unbacked digital dollars.  With $20B in question, it’s almost certain that United States author­i­ties are keeping a close eye on the banking activity under­pin­ning Tether’s operation.

What’s the future for Tether?

Tether enjoys a large early lead in the digital synthetic dollar market, but competi­tors like USDC have sprung up and purport greater trans­parency and regulator-friendly gover­nance.  The quali­ties of these newer entrants may chip away at Tether’s lead and eventu­ally replace it as the preferred digital dollar in time. 

However, it may be that Tether’s scrappy origins and less open relation­ship with banking regula­tors provide it a subtle staying power.  For users in China seeking to hold Tether as an alter­na­tive means to holding dollars, Tether’s reputa­tion of being less cooper­a­tive with regula­tors than its competi­tors could be perceived as positive.  For these users who are seeking dollar exposure that is less resis­tant to govern­ment seizure or shutdown, that less friendly stance towards regula­tors may help keep Tether as the preferred digital dollar into the future.

This blog offers thoughts and opinions on Bitcoin from the Swan Bitcoin team and friends. Swan Bitcoin is the easiest way to buy Bitcoin using your bank account automatically every week or month, starting with as little as $10. Sign up or learn more here.

Daniel Matuszewski

Daniel Matuszewski

Dan is the principal and co-founder of CMS Holdings. Previously Dan was Head of Trade at Circle and on the early team at Kraken.

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© 2021 Swan Bitcoin

Electric Solidus LLC
26565 Agoura Rd Ste 200
Calabasas, CA USA
hello@swanbitcoin.com
+1.218.379.7926
Swan Bitcoin does not provide any investment, financial, tax, legal or other professional advice. We recommend that you consult with financial and tax advisors to understand the risks and consequences of buying, selling and holding Bitcoin.