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Tether (USDT) | Definition, How It Works, and Pros and Cons

Published July 28, 2023 12:19 PM

By Andrew Kamsky

Tether (USDT) | Definition, How It Works, and Pros and Cons. | Credit: Shutterstock

Key Takeaways

USDT offers stability and liquidity in the cryptocurrency market due to its peg to the US dollar.
There is a risk of depegging, where USDT’s value may deviate from the 1:1 peg.
Concerns have been raised about USDT’s transparency and regulatory compliance.
Users should diversify holdings and conduct due diligence to mitigate risks associated with USDT.

What Is Tether (USDT)?

Tether (USDT) is a cryptocurrency stablecoin that is pegged on a one-to-one ratio to the value of the United States Dollar (USD). It was founded by Reeve Collins, Craig Sellars, and Brock Pierce and was launched in July 2014. It plays an important role in the crypto space as it provides traders a stable digital asset that maintains its steady valuation. Its value is designed to always be equivalent to $1 USD, regardless of market conditions. Tether is owned by iFinex, a Hong Kong-registered company that also owns the cryptocurrency exchange BitFinex.

The stablecoin has gained significant popularity in the cryptocurrency market, and as of July 2023, it holds the third spot in terms of market capitalization just behind Bitcoin and Ethereum respectively, making it the largest stablecoin, with a market cap of nearly $86 billion.

Is USDT The Same As USD?

No, USDT (Tether) is not the same as USD (U.S. Dollar). USDT is a cryptocurrency stablecoin pegged to the value of the U.S. Dollar, but it is a digital asset built on blockchain technology. In contrast, USD (U.S. Dollar) is the official currency of the United States and is a fiat currency issued and regulated by the U.S. government. It exists in physical form as coins and banknotes, and it also exists digitally in various financial systems.

How Does Tether (USDT) Work?

Tether maintains its USDT peg to the United States Dollar (USD) in a one-to-one peg ratio by adopting a technical mechanism whereby each USDT is backed 100% by Tether’s reserves, as per the company’s official website . Hence, by backing the total amount of USDT in circulation with the equivalent sum of dollars and other assets this essentially means that each USDT token is backed by one dollar in reserves.

This reserve backing is intended to instill confidence in the market that each USDT can be redeemed for its equivalent value in USD at any time. In theory, this mechanism should help keep the value of USDT stable and close to the value of one USD.

The value of the Tether reserves is published daily for transparency purposes and is published on their website, updated at least once per day. BDO Italia serves as the author of Tether’s accounts and reports. Despite the efforts to stabilize the value of USDT, there have been various de-pegging events, as explained in the below section.

Tether (USDT) De-pegging Events

Due to a spike in unfavorable sentiment that appeared to spark a sell-off of Tether tokens around October 15, 2018 USDT saw a drop below the $1 mark. Additionally, Tether and Bitfinex, the exchange involved in creating the tokens, had broken their links with Noble Bank in Puerto Rico, which may have contributed to the decline in the value of Tether.

USDT saw a little departure from its customary peg to the US dollar on June 15, 2023. An imbalance in Curve’s 3 pool was the root cause of this aberration, which caused the price of USDT to drop by 0.3% to roughly 0.997. The USDT’s weight in the Curve 3 pool increased from its typical amount of 33.1% to nearly 70%.

How Does Tether (USDT) Generate Income?

Tether generates income through various means, and one significant source is the interest earned on its reserve assets. Tether can lend a portion of their reserve assets to other parties and earn interest on those loans. This interest income can contribute to covering the costs of maintaining the stablecoin’s peg and generating profits for the company. Seeing as they can earn between 4% and 6% on investments and invest billions of dollars, the interest earned is significant and so far a viable business model.

Tether generates other forms of income by applying various charges on transactions and services offered on their platform. These charges encompass:

Transaction fees for fiat deposits: Tether levies transaction fees on new fiat deposits made on their platform. Presently, this fee stands at 0.1% of the deposited amount, with a minimum deposit threshold of USD 100,000.
Redemption fees: When users convert Tether tokens into fiat currency, they are subject to redemption fees. The specific fee structure depends on the redemption amount and the particular terms and conditions set forth by Tether.
Verification fee for KYC process: Tether may impose a verification fee on new accounts undergoing the Know Your Customer (KYC) process to ensure compliance with regulatory standards. This process involves confirming the identity of the account holder and is designed to prevent illicit activities like money laundering.

How To Buy And Sell Tether (USDT)?

To buy Tether (USDT) follow these steps:

Choose a Reliable Cryptocurrency: Search and choose an exchange that offers Tether (USDT) trading.
Make an account with the exchange: Create an account and keep in mind most exchanges require users to provide identification documents for compliance purposes.
Deposit funds into the exchange account: Use various payment methods like credit/debit cards, bank transfers, or cryptocurrencies to fund your account.
Buy Tether (USDT) using said funds: Once you deposit the fund in your exchange account, navigate to the USDT trading pair and place a buy order for the amount of USDT you wish to purchase. You can buy USDT directly with fiat currencies or use other cryptocurrencies like Bitcoin or Ethereum to exchange for USDT.
Store USDT in a reliable digital wallet: After purchasing USDT, you have the option to store it in a cryptocurrency wallet. Hardware wallets, software wallets, and exchange wallets are available. For enhanced security, consider using a hardware wallet.

To sell Tether (USDT) follow these steps:

Choose a reliable cryptocurrency exchange: Select a reputable cryptocurrency exchange that offers USDT trading and selling options.
Log into your exchange account: Sign in to your exchange account and complete any necessary verification processes.
Find the USDT trading pair: Locate the USDT trading pair you want to use for selling, such as USDT/BTC or USDT/ETH.
Place a sell order: Enter the amount of USDT you want to sell and specify the price (if desired). You can also choose a market order for immediate selling at the current market price.
Confirm the transaction: Review the sell order details and confirm the transaction. Once executed, you will receive the proceeds in the form of the cryptocurrency you sold USDT for.

Pros Of USDT

There are various benefits to using USDT (Tether) in the cryptocurrency market:

Stability: Due to its peg to the US dollar, the USDT is a reliable choice for traders and investors looking for a relatively stable store of value in the face of market turbulence.
Liquidity: Because it is extensively used and traded on several exchanges, USDT has great liquidity, making it simple for users to buy, sell, or trade it.
Faster transactions: Compared to traditional banking systems, USDT transactions use blockchain technology to enable faster transfers and settlements.
Decentralization: Despite coming from Tether Limited, USDT operates in a decentralized cryptocurrency ecosystem, giving users access to the advantages of the blockchain.
Risk hedging: During volatile market times, traders frequently utilize USDT as a hedge to protect their money from severe price swings.
Seamless exchanges: Bypassing slower and more expensive traditional banking methods, USDT enables quick financial transfers between various cryptocurrency exchanges.
Worldwide accessibility: USDT is reachable from anywhere in the world, encouraging financial inclusion in areas with weak banking infrastructure.
Trading pairs: USDT is a frequently used base trading pair that makes it possible to easily convert and trade between different cryptocurrencies.

Cons Of USDT

USDT (Tether) has faced criticism and concerns due to the following drawbacks, including the risk of depegging:

Depegging risk: The primary issue with the USDT is the possibility that it will break its 1:1 peg to the US dollar. While traditionally it has been able to keep this peg, there have been times when there have been brief variations, which might reduce confidence in the stablecoin.
A lack of transparency: Tether Limited’s partial transparency and independent audits of its currency reserves have raised concerns about the real backing of USDT tokens. The community of bitcoin users and regulatory bodies have expressed distrust as a result of this lack of openness.
Regulatory scrutiny: Several regulatory organizations throughout the world have expressed concern about USDT’s centralized structure and the possibilities for partial regulatory noncompliance. Its long-term use and viability may be impacted by this regulatory ambiguity.
Counterparty risk: Users that store USDT on exchanges are subject to counterparty risk because they are effectively relying on the exchange to keep and administer the underlying fiat reserves. Users’ USDT holdings may be at risk if an exchange experiences financial difficulties or security breaches.
Limited use cases: Despite being often utilized for trading and money transfers between exchanges, USDT’s functionality is constrained when compared to other cryptocurrencies. It lacks the smart contract functionality and programmability that cryptocurrencies like Ethereum provide.
Competing stablecoins: The emergence of competing stablecoins like USDC and DAI, which offer greater transparency and regulatory compliance, has heightened competition for USDT. This competition might have an impact on its market dominance.
Market manipulation concerns: Due to its substantial trading volume in the cryptocurrency market, USDT has come under fire for allegedly being used to manipulate cryptocurrency prices.
Centralized issuer: Concerns regarding possible censorship or poor management arise because Tether Limited, the issuer of USDT, has considerable control over its operation..

Is USD To USDT Taxable?

Converting US dollars to USDT (Tether) is generally not a taxable event in itself since it’s merely an exchange between fiat currency and a cryptocurrency. However, depending on your nation and area, tax laws and regulations may differ.

When you sell or swap USDT back into USD or another cryptocurrency, there may be capital gains tax applicable in some jurisdictions for those transactions. For tax purposes, it’s critical to keep proper records of your cryptocurrency transactions and be informed of local tax regulations.

Is Tether USDT A Good Investment?

The main purpose of USDT is to enable investors and dealers to transfer money quickly between various cryptocurrency exchanges without having to go through conventional banking institutions. USDT is not meant to produce capital profits or offer long-term investment possibilities, in contrast to other cryptocurrencies. As a result, it isn’t seen as a traditional investment in the sense of looking to make money from price growth.

Moreover, it is critical to realize that every investment involves some level of risk. There are particular risks related to technology, market volatility, regulatory changes, and the durability of the peg to the US dollar when it comes to cryptocurrencies like USDT.

The controversy and partial openness surrounding Tether (USDT) in the past have also raised issues. Therefore, one must conduct extensive research, comprehend the risks, and only invest money they can afford to lose when making an investment decision.

Conclusion

In the cryptocurrency industry, USDT (Tether) is a widely utilized stablecoin that provides some advantages and conveniences. Because of its relative stability and peg to the US dollar, it is a popular option for traders and investors looking to safeguard their assets during periods of market turbulence. Transactions between other cryptocurrencies and exchanges can be completed quickly because of USDT’s liquidity and seamless exchange capabilities.

However, USDT is not without its difficulties and challenges, though. Depegging risk and incomplete disclosure surrounding its currency reserves have stoked regulatory concern. Users who hold USDT on exchanges need to be aware of potential counterparty risks. The advent of rival stablecoins with greater regulatory compliance and transparency could have an effect on USDT’s long-term market dominance.

FAQs

What is USDT (Tether)?

USDT is a stablecoin cryptocurrency issued by Tether Limited. It is designed to maintain a 1:1 peg with the US dollar, providing relative stability compared to other volatile cryptocurrencies.

How does USDT maintain its peg to the US dollar?

USDT’s peg is maintained through Tether Limited’s claim that each USDT in circulation is backed by an equivalent amount of real-world fiat currency, typically USD, held in reserve. However, concerns have been raised about the transparency and regular auditing of these reserves.

What is the risk of depegging for USDT?

Depegging refers to a situation where the value of USDT deviates significantly from its 1:1 peg with the US dollar. While USDT has historically managed to maintain its peg, there have been instances of temporary deviations, which can lead to a loss of confidence and market uncertainty.

How can USDT be used in the cryptocurrency market?

USDT is widely used as a stable store of value and as a base trading pair on cryptocurrency exchanges. It allows users to move funds quickly between different exchanges without relying on traditional banking systems.

What are the concerns regarding USDT’s transparency and regulatory compliance?

USDT has faced criticism for its lack of complete transparency, particularly regarding its fiat reserves. Additionally, regulatory authorities have raised concerns about Tether Limited’s compliance with financial regulations, leading to increased scrutiny.

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