Why Tether is central to the global cryptocurrency market

The fall in price of Tether has ratcheted up tensions in the jittery cryptocurrency markets, underscoring the stablecoin’s central role behind daily trading of digital assets such as Bitcoin.

While it is supposed to be pegged to one-to-one with the US dollar, Tether traded as low as 95.11 cents on Thursday before recovering some of its poise as it took to social media to reassure markets.

Tether’s swoon heaped further pressure on a cryptocurrency market reeling from a collapse in value of TerraUSD, a much smaller stablecoin.

Here’s a guide to why Tether plays such an important role in the crypto market and what could happen if it malfunctions.

What is a stablecoin and why does Tether matter?

Stablecoins are a type of cryptocurrency pegged to other assets to reduce their volatility and play a crucial intermediary role between hard currencies such as the US dollar and euro and digital tokens such as Bitcoin and Ether. Using regular dollars to buy crypto can be difficult for traders, as settlement is slow and the price of currencies such as Bitcoin can change significantly.

Traders instead typically use traditional currencies to purchase stablecoins, which are accepted on dozens of crypto exchanges. That allows traders to buy and sell volatile digital assets more quickly.

Tether has issued more than $ 80bn of coins for circulation, making it the largest stablecoin in the digital marketplace and a core source of liquidity for the crypto economy.

Central to its operation is the company’s pledge that tether is pegged on a one-to-one basis with US dollars and that it is fully backed by its reserves of assets, such as US government bonds, short-term corporate debt and a relatively small amount of cash.

Tether’s market position, with 50 per cent of market share, is still some way ahead of second-place USD Coin, which has 30 per cent according to crypto data site CoinGecko.

It is the oldest stablecoin on the market and continues to dominate stablecoin usage, particularly in markets outside of the US. USD Coin, which was launched in 2018, has positioned itself as a more US friendly option.

Circle, which jointly operates USD Coin with Coinbase, has also increasingly pivoted to promoting its use for non-crypto money transfer purposes.

Tether, like other stablecoins, is also used on “yield platforms”, which lend out digital tokens at a higher rate than they offer to clients.

Tether has also found some offline usage outside of the US as a dollar alternative where access to the real thing is more limited. In December, Myanmar’s opposition National Unity Government announced it had recognized Tether as an official currency.

Why is Tether controversial?

Critics have frequently queried Tether’s attestations that its tokens are fully backed by assets.

The New York attorney-general’s office and the US derivatives regulator Commodity Futures Trading Commission have collectively fined the company nearly $ 60mn over claims that it falsely represented that its tokens were fully backed by dollars until 2019. Tether settled both cases without admitting or denying liability .

Following its settlement with New York officials, Tether began posting financials showing a breakdown of it reserves. As of December, almost a quarter is still in commercial paper, a form of short-term debt. Tether has not disclosed the identity or provenance of the commercial paper’s issuers, beyond stating that some of its holdings are international.

What happens if Tether loses its peg against the dollar for a sustained period?

Although stablecoins are marketed as stable, in practice they constantly fluctuate. A report from JPMorgan in July last year found that the four largest stablecoins had spent between 30-40 per cent of the preceding three months trading below par.

However, these fluctuations tend to be relatively small. If Tether lost its one-to-one peg with the US dollar by a wide margin for a long period, it could have a destabilizing impact on the crypto market.

Crypto traders who hold large reserves in Tether would find their holding were worth less, which could force them to sell other tokens, and prompt a rush to claim dollars in exchange for their devalued Tether coins.

As people rushed to redeem their tethers for dollars, the stablecoin’s backers would have to sell the traditional assets they claim to hold in order to pay up. The flood of selling could disrupt major traditional markets, such as those for short-term corporate debt or government bonds.

Central bankers around the world are wary that the impact of a collapse of a stablecoin could spread into traditional financial markets. Earlier this week US Treasury secretary Janet Yellen warned that Terra’s falling value illustrated that stablecoins were “a rapidly growing product and there are rapidly growing risks”.

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