Tether, developed by the defunct cryptocurrency exchange BitFinex, is a type of cryptocurrency whose value is pegged to the price of the U.S. dollar. It is one of the most popular stablecoins in the market today. This guide will explain what Tether is and how it works.
Cryptocurrency – A Volatile Asset
Most cryptocurrencies serve as a medium of exchange and not just a store of value. However, the challenge is that their value (price) keeps fluctuating – volatile. One of the reasons for this volatility is a small market cap. Usually, the smaller the market cap, the more volatile an asset becomes. If you were to through a rock into a lake, the ripple effect would be almost insignificant.
However, if you were to through the same stone into a swimming pool, it will have much more effective. Similarly, the cryptocurrency market still has a small market cap compared to fiat currencies such as the US dollar. Therefore, frequent transactions can affect the market prices significantly.
Volatility creates problems since users cannot enjoy the benefits of virtual currencies as the value keeps shifting. Imagine how hard it can be using Bitcoin for day-to-day transactions when the prices keep changing. Imagine if you are paid in Bitcoin today, and tomorrow the value drops by half! Or, how does it feel to be Laszlo Hanyecz, the person who bought Pizza for 10,000 bitcoins in 2010!
This is where the stablecoins come in.
What is a Stablecoin?
A stablecoin is a cryptocurrency whose value is pegged on a real-world currency (fiat currency) or any other exchange-traded commodity such as precious metals. These tokens are issued by central companies that implement strategies to maintain the peg. They can put up collateral for the token.Alternatively, they can create an algorithm that manipulates token supply in response to the demand.
Fiat-backed stable coins allow exchanges to create crypto trading pairs without accepting fiat. For example, an exchange can have an ETH/USDT trading pair, and avoid regulations associated with trading the U.S. dollar. Stablecoins minimize the price movements of the digital currency. Let us consider the price of USDT, which is pegged on the U.S. dollar in a ratio of 1:1. The price of USDT will only move as much as the price of the U.S. dollar moves.
Nonetheless, stablecoins have the same common features as cryptocurrencies. They run on a decentralized blockchain. Therefore, they are decentralized and immutable.
While USDT’s reserve and issuance system are still unclear, it is still the most consistent and strongest stablecoin in the market.
What is Tether
Tether (₮) is a cryptocurrency pegged to fiat currency. It uses the U.S. dollar as its most popular peg (USDT). The stable coin is pegged to the U.S. dollar at a ratio of 1:1. Therefore, 1 USDT is equal to $1. You can look at it as a crypto dollar, at least in value. Tether also uses Euro, in the form of (EURT). Again, the price of 1 EURT is equal to €1.
Tether is still exposed to the fluctuation in the value of the underlying fiat currency. For example, if the value of the U.S. dollar would halve overnight, USDT would lose an equal amount of value. Also, if the value of gold suddenly drops, the value of the respective stablecoin will drop equally.
How does Tether Work?
USDT is pegged to USD at a ratio of 1:1 (Source: quora.com)
Initially, all Tether tokens lived on the Omni platform, which is built on top of the blockchain network. The platform is used for creating and trading custom digital assets and currencies. Ethereum based Tether was launched, after the Bitcoin Tether. Currently, the Ethereum blockchain has become Tether’s most utilized network. However, the tokens exist in more than eight blockchains including Solana, OMG Network, and Tron.
The Tether uses a collateral peg, where a US dollar or other assets is sitting in deposit for every 1 USDT that exists. 1 USDT is redeemable at any time for $1 of fiat currency.
Currently, you can convert USDT to USD directly through the Tether platform or some exchanges. You need a minimum of $100,000 and considerable fees to use the Tether platform.
What are the Advantages of Tether?
Volatility is the main feature that makes trading crypto interesting to most investors. You can easily earn high interest by buying the virtual assets high and selling them low. Therefore, you might question the purpose of Tether, which maintains a fixed price.
Buying Tether may sound like buying an asset that earns 0% yet have risks. If holding Tether is riskier than regular crypto tokens and with no promise of gains, why should you use it? In reality, Tether is a very useful crypto asset for traders and investors. It perfectly plays the role of fiat in the crypto environment. Here are some areas where Tether wins:
Depositing and withdrawing transactions to and from foreign exchanges is usually time-consuming. Such processes can take between 1 and 4 working days to complete. This wait time may be extended when the bank closes for a weekend and holidays. Such a long waiting time is often inconvenient to traders.
Contrary, processing Tether transactions take minutes to complete. Therefore, traders can shift funds fast and easily, and take advantage of the arbitrage opportunities.
SWIFT payments are expensive. Averagely, you will pay $30 to make international transfers via SWIFT. Additionally, transferring fiat currencies rather than those supported by the exchange attracts other charges such as foreign exchange fees.
On the other hand, Tether does not charge transaction fees between Tether wallets. However, your Tether transactions still attract the standard blockchain network fees. Nonetheless, such fees are minimal compared to SWIFT transfer charges.
The majority of cryptocurrencies are very volatile. Trading a volatile currency for another is complicated and involves significant risks. On the other hand, Tether presents a stable digital asset, hence nullifying the volatility risks. Think of the following scenario: You sell your BTC and buy ETH. The price of ETH increased by 10% and now you want to convert them back to BTC to make a profit. Suddenly, the price of BTC falls by 15%.
In this case, you will run a loss despite being correct on the price move for ETH. If you were to use BTC, in this case, your only concern would be ETH.
Getting off the Volatile Market
Sometimes the best position to take in a volatile market is no position. Let us say you are holding a virtual asset that you feel is very stable, you can convert them to USDT and get off the volatility risk that may eat up the value of your reserve.
Tether: Wrapping Up
Tether is closer to the fiat banking system beyond its obvious fiat linkage. Unlike other cryptocurrencies such as Bitcoin, it is centralized, permission, and trust-dependent. Consequently, some crypto enthusiasts are skeptical about it.
Nonetheless, Tether still plays an important role in shielding holders against the highly volatile crypto market. The future of this stable coin is still in question by some crypto investors, who think it may crash. Therefore, if you want to use Tether, you should avoid storing large sums of funds in it. You should use it with caution – for short-term trading and transfers.