What Is Tether (USDT) and How Does It Work?

In our article, “What Is Tether (USDT) and How Does It Work?”, we delve into the intricacies of Tether, a cryptocurrency stablecoin pegged to the US dollar. Launched in 2014, Tether has ascended to the position of the largest stablecoin by market capitalization, primarily due to its claim of being fully backed by fiat reserves and financial instruments. It serves as a pivotal asset in the crypto trading landscape, offering stability and ease of value transfer across multiple blockchain networks. We explore Tether’s mechanism for maintaining its peg, its adoption, and the broad implications for daily users, merchants, and traders within the crypto ecosystem. The article also includes an analysis of Tether’s quarterly reserves report and the rigorous protocols involved in its issuance and redemption process, underlining its significance in bridging the gap between fiat currencies and digital assets. Have you ever wondered what makes Tether (USDT) such a significant player in the cryptocurrency space? Let’s delve into what Tether is, how it operates, and why it has garnered so much attention.

What Is Tether (USDT) and How Does It Work?

What Is Tether (USDT)?

Tether, also known as USDT, is a cryptocurrency stablecoin pegged to the value of one US dollar. Since its launch, Tether has grown into the largest stablecoin by market capitalization. It claims to be backed by fiat reserves and other financial instruments and is natively available across 16 different blockchains.

Key Takeaways

• USDT Reserves: Tether claims to be 100% backed by an equivalent amount of reserves held by its issuer, Tether Limited, to maintain the stablecoin’s peg to 1 US dollar.
• Asset Composition: Tether’s reserves mainly consist of US Treasury Bills and other cash equivalents, along with small allocations to secured loans, precious metals, Bitcoin, and other investments.
• Centralized Control: USDT is a centralized stablecoin, allowing Tether to freeze transfers in compliance with law enforcement and government requests.
• Market Leader: Since its inception, Tether has grown to become the largest stablecoin by market capitalization and has attracted significant scrutiny regarding the transparency and traceability of its reserves.
• Multi-Chain Presence: Over the past decade, USDT has expanded beyond the initial Bitcoin Omni Layer to a variety of different blockchains, with native USDT now being issued on 12 different networks.

Introduction to Tether (USDT)

Launched in 2014 by Tether Limited, Tether (USDT) is a token with stable value relative to the US dollar, enabling users to retain and transfer value on the blockchain. Tether has emerged as the most popular asset pair for crypto trading, boasting the highest volume among all coins.

As a stablecoin, Tether is pegged to the value of 1 US dollar and claims to be fully backed by Tether’s assets and reserves. The breakdown of these reserves, which mostly consist of US Treasury Bills and other cash equivalents, along with small allocations to secured loans, precious metals, Bitcoin, and other investments, can be observed through the firm’s quarterly Reserves Report.

A key promise of Tether is the ability to redeem the tokens for fiat currency. Users can exchange their Tether tokens for cash from the platform’s reserves. However, users need to establish a verified Tether account by undergoing anti-money laundering checks and KYC procedures. There is a $150 verification fee, and holders need to redeem a minimum number of tokens equivalent to 100,000 USD and pay a 0.1% redemption fee. Despite these barriers, most centralized crypto exchanges (CEXes) typically offer a way for users to offramp their USDT.

What Is a Stablecoin?

A stablecoin is a digital token whose value is tied to another asset, like a commodity or fiat currency, to stabilize its price. By maintaining a 1:1 peg to a specific fiat currency, asset, or commodity, stablecoins act as a bridge between real-world assets and digital currencies by representing them as tokens on the blockchain. Because they are pegged to relatively stable assets, stablecoins have become the most popular way for crypto users to transfer value without exposing themselves to price volatility. They also serve as a store of value for crypto users, enabling them to keep their capital on-chain even as they stay out of the market.

Types of Stablecoins

Not all stablecoins are fully backed by real-world assets. Some use a combination of on-chain assets and smart contract algorithms to protect their peg. For example:

• Overcollateralized Stablecoins: Stablecoins like DAI, crvUSD, and GHO are overcollateralized by other crypto assets such as ETH and BTC, and have a liquidation mechanism if the value of the collateral falls too low.
• Algorithmic Stablecoins: Ampleforth uses a rebasing mechanism that adjusts the supply of stablecoins in the market to preserve price parity with the US dollar. These types do not guarantee redemption for equivalent USD since they are not backed by real fiat reserves.

Pegged Assets

Some tokens claiming to be stablecoins are pegged to more fluctuating assets. For example, frxETH follows the value of Ether. Tokens pegged to commodities like oil and uranium are more volatile compared to the average US-dollar stablecoin. These tokens are more accurately referred to as pegged assets.

How Does Tether (USDT) Work?

All of Tether’s stablecoins are backed by a basket of various assets, at least equal in value to the amount of stablecoins in circulation. Tether’s reserves consist of cash and cash equivalents, like Bitcoin, precious metals, corporate loans, and other investments. Reserve reports published quarterly detail the breakdown of their holdings. Additionally, the number of stablecoins in circulation is updated daily, and users can check the number of tokens authorized and issued natively across Tether’s supported blockchains and bridges.

Issuance Process

Tether tokens can be created on a specific network by having multiple authorized individuals sign and broadcast the transaction to generate them. These new tokens are stored in Tether’s treasury until a customer acquires them directly using fiat. This minimizes the risks of exposure by limiting access to the private keys.

Upon purchase, Tether tokens follow these steps:

1. Fiat Deposit: A user with a verified Tether account deposits fiat currency into Tether’s real-world accounts.
2. Token Issuance: Tether tokens are issued from the treasury to the user’s specified wallet address. The value of tokens received will be slightly less than the deposited funds after fees.
3. Token Usage: Users can store or transfer tokens to other wallets or interact with dApps on their preferred network.

Maintaining the Peg

Tether ensures that the total sum of circulating USDT and other stablecoins is fully backed by reserves. Before authorizing the issuance of more stablecoins, Tether ensures that reserve assets are sufficient to retain USDT’s peg at one US dollar.

When holders choose to redeem their USDT for fiat currencies, the corresponding tokens are burnt, reducing the circulating USDT tokens on that blockchain. Alternatively, tokens can also be removed from circulation and held in the treasury for future issuance. On rare occasions, Tether has the power to blacklist and burn tokens from the wallets of exploiters and bad actors in accordance with demands from authorities.

Advantages of USDT

While volatility is a hallmark of the crypto industry, stablecoins offer users a stable form of currency to conduct trades or payments. Tether is no different, offering unique features and advantages that help users navigate the crypto market.

Widespread Adoption and Deep Liquidity

Tether’s popularity has led to USDT being widely accepted by a range of centralized exchanges across multiple chains. This allows users to easily move their funds using USDT without converting to other assets. The integration of USDT in decentralized applications, such as lending platforms, adds further utility as a more stable form of collateral.

Versatility in Different Use Cases

Tether’s stable value makes it ideal for a range of use cases beyond trading. Everyday users can utilize Tether as collateral or transfer funds quickly and cheaply without relying on legacy banking systems. Merchants can integrate Tether as a digital payment method, allowing users to make real-world purchases directly with the stablecoin. Tether plays a crucial role in both centralized and decentralized exchanges as a popular trading pair against various crypto assets.

The Tether Ecosystem

Tether has expanded beyond just a fiat-backed stablecoin. Various representations of USDT can be found on numerous blockchains and Layer 2 solutions. Most of these are wrapped or bridged versions of the original tokens, initially issued on networks like Ethereum, Tezos, and Tron.

Other Fiat-Collateralized Stablecoins

Apart from USDT, Tether has issued stablecoins pegged to other fiat currencies and commodities. Popular examples include EURT (pegged to Euros) and Tether Gold (XAUT), which follows the value of one troy ounce of gold.

Tethered Assets

Moving beyond traditional stablecoins, Tethered Assets use different stability mechanisms, such as over-collateralization and secondary liquidity pools, to track the reference price of different assets. For instance, Alloy, a US dollar-pegged stablecoin, is backed by Tether Gold, allowing holders to gain access to dollars while maintaining gold exposure.

Conclusion

Tether (USDT) has undeniably become a cornerstone in the cryptocurrency space, offering stability in an otherwise volatile market. Its widespread adoption, deep liquidity, and versatility in different use cases make it an indispensable asset for both traders and everyday users alike. As the largest stablecoin by market capitalization, Tether continues to evolve and expand, solidifying its role as a fundamental anchor in the crypto ecosystem.