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Tethered in Legacy

July 22, 2020 • 
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Why Tether (USDt) could become more useful than the currency that underpins it.

The often controversial project is no doubt one of the more interesting and potentially paradigm shifting assets in the crypto space. In this article we will explore why Tether (USDt) could become more useful than the asset that underpins it, and the wide ranging use-cases which will dictate it’s utility.

Before that however, let’s get back to basics.

What is Tether?

As compared to traditional fiat currencies, digital assets have a volatility problem. The “problem” (if that is even the right word) is a double-edged sword as while it has attracted investors, the price moves too much for it to be a reliable form of currency at this point and throughout its existence.

As a remedy to this, Tether aims to be a stable mechanism that is pegged (literally tethered) to the USD by cash reserves, that in theory represent the US Dollar 1:1.

Put more simply, Tether is the USD on a blockchain.

Tether is part of a wider group of assets known as stablecoins which are in most cases designed to be underpinned by real-world assets (gold, silver, USD etc) and then as a result of this more stable than other embryonic crypto assets.

Cursory overview of use case scenarios;

  • Cross-border, stable & liquid digital currency
  • Preferred pairing for OTC transactions
  • Preferred treasury of digital asset exchanges
  • Accepted on every major exchange
  • Easy access to Forex markets (AUD/USD hedge)
  • Preferred on and off-ramp pairing.

The most traded cryptocurrency in the world

Given that Bitcoin makes up almost 65% of the entire crypto market, you could be forgiven for thinking that it would also be the most traded — but you would be wrong.

Tether has consistently had the most volume for the best part of a year now, and this is at least partly to do with both demand on OTC desks and it’s remittance utility.

OTC refers to the transactions that are done “over-the-counter” or off-exchange, where the trading is done directly between two parties. So party A is buying the asset, and party B is selling — and OTC desk will broker in both directions.

While it is hard to track down specific numbers, OTC trade for Bitcoin is becoming much more appealing for large transactions due to the perils of slippage and low liquidity trading on exchange. Instead of large traders buying on market and signalling their intent, market movers can access ring-fenced liquidity pools, which allow for price guarantees and minimal slippage whether they are buying 1 BTC or 1000.

As Morgan Stanley reported as early as July 2019, most Bitcoins are bought with Tether. In many cases this is because exchanges don’t offer fiat pairs, so it is not only more accessible to trade using USDt but it is also cheaper to do so.

This fact is true of OTC transactions as well.

As Su Zhu of Three Arrows Capital recently spoke to in a piece for BTC derivatives exchange Deribit;

“Trust enables the broker to cater to their clients’ specific needs, and it also enables the client to bestow on the broker highly secretive information. This cannot be replicated or improved upon by decentralization–in fact, it is its very antithesis.”

As an extension of this Coindesk reported in July 2019 of the rising demand for Tether as a remittance tool between China and Russia.

Anna Baydakova reported at the time;

Why tether? It has the usual advantages of crypto — no limits on how much money can be sent or where — without the volatility that makes most coins infeasible for moving millions across the border daily.

Another important point is that Tether is the preferred on and off rail for the Chinese Yuan into and out of crypto despite the People’s Bank of China (PBoC) ban on fiat-to-crypto spot trading. In fact, the rise of USDt within Chinese cryptocurrency trading is a direct result of the cryptocurrency-related ban.

A 2019 report by blockchain research company Chainalysis states that;

“for Chinese exchange users, Tether has replaced the yuan as the go-to fiat currency.”

This is at least partly because Tether can be liquidated back into Chinese Yuan on registered exchanges like OkEx and Huobi.

The Yuan can then be received via WeChat Pay, AliPay or banks and the bridge between the digital and legacy financial worlds becomes practically seamless.

Tether is central to the DeFi Ecosystem

Stablecoin demand is exploding right across the digital landscape, and Tether is unquestionably leading that charge. Tether started 2020 with a market cap of around $3Billion USD, and has ballooned to over $9Billion USD at the time of writing this.

While it is a true statement that Tether production has historically been a very bullish sign for Bitcoin, this major surge in demand is being attributed to;

  • Increased demand for OTC transactions
  • Investors wanting to reduce risk from Bitcoin and other assets
  • Investors wanting to hedge positions between digital assets and legacy markets (with assets in one place).

Another driving factor however is the exploding popularity of DeFi platforms. Decentralised Finance is in essence the practise of leveraging a decentralised network to replace the traditional functions of banks, such as contributing and lending capital.

The reason this practise is becoming so popular is because of the super-appealing interest rates on offer which are many magnitudes higher than those offered in the legacy banking system.

Compound, a decentralised lending market, is spearheading growth in the nascent decentralised finance (DeFi) space as USDt volume on the platform has surged above USD 100 million in the last week.

“Tether is an extremely useful asset in the Compound ecosystem, and has quickly become one of the most liquid markets in the Compound protocol and accordingly across all of DeFi,” says Calvin Liu, Strategy Lead at Compound. “USDt’s growth on Compound has been faster than the growth of any other asset in the protocol, by multiples.”

USDt lenders currently yield around 4.4% but it has been as high as 11% in recent days, while borrowers are currently paying about 12%. These rates will change dynamically based on the supply/borrow markets equilibrium.

USDt has USD 184 million supplying capital, and USD 76 million borrowing, representing 3045 suppliers and 752 borrowers, according to data provided by Compound.

Controversy

Tether is increasingly becoming more and more critical to the crypto environs, but has not been without controversy.

Whether or not USDt is fully-backed has long been a point of contention.

Initially the coin was advertised as having a 1:1 cash backing, however in a New York Supreme Court ruling on that matter, general counsel to Tether Stuart Hoegner wrote in an affidavit that USDt was backed by;

“cash and cash equivalents … representing approximately 74 percent of the current outstanding tethers.”

At the time some were outraged by this, but as Nic Carter from Castle Island Ventures outlines, this is no different to the way banks operate by loaning out more money than they have on hand via the accepted fractional reserve banking system.

On November 7th 2019, Tether released a statement that refuted criticism of its business model, and made the claim that they were now fully backed again.

All Tether tokens are fully backed by reserves and are issued pursuant to market demand.

Even though it is unclear exactly what percentage of the stablecoin is backed at all times (whether 74% or higher), it should be noted that Tether is universally redeemable for reserve assets at all times, across all crypto exchanges.

TLDR

The takeaway is this, Tether is a crucial instrument within the crypto landscape. It is crucial to every major exchange, OTC desk, and DeFi lending marketplace available, and as such plays a crucial role as both a connection to legacy markets and as a hedge against crypto volatility.

Given the additional advantages of the blockchain in terms of borderless transactions & instant settlements it becomes an ideal instrument for international remittance and exchange.

These are some of the reasons why a cogent argument is beginning to form that Tether could have more utility than the asset that underpins it, and as crazy as that sounds — one should only look out the window and realise we are living in strange and unusual times.

To keep looking at the world through the same lens you did even 10 years ago is to be financially negligent to the digital economic transformation that is well under way.

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