Tether (USDT) and the Cryptocurrency Ice Age

What is Tether and why is it a ticking time bomb? What makes Vitalik Buterin think it’s a “bitcoin-only” problem?

In 2009, a young man named Satoshi Nakamoto …… Sorry, that’s probably too far back. So, let’s start with 2021.

On the Tim Ferris Show, hosted by Naval Ravikant, discussing the future of cryptocurrencies, Vitalik Buterin highlighted some of the things that could open Pandora’s box “I think the Bitcoin ecosystem does have its own ticking time bomb. Tether, for example, is an example.

What is Tether, and why is it a ticking time bomb? What makes Vitalik Buterin think it’s a “bitcoin-only” problem?

On the contrary, some have labeled it as a cryptocurrency Lehman Brothers, potentially sending cryptocurrencies into an “ice age” and possibly preventing its further adoption (in the best case scenario) or collapsing the entire cryptocurrency world (a point that Nassim Nicholas Taleb has repeatedly warned is an obstacle or irreversible).

In the case of Lehman Brothers, the paradox of centralized power is that it ultimately prevented a systemic collapse. In fact, core players like the Federal Reserve and the government saved the financial system (first with the bailout of AIG, and then with the Troubled Asset Relief Program, which injected $700 billion of liquidity into the financial system).

In the crypto space, without the killer app responsible for guarding against systemic risk, everything can go wrong. Does this mean the end of everything?

I believe it is critical to answer these questions to ensure that we continue to see the blockchain and crypto ecosystem evolve and the Web 3.0 we dream of truly come to fruition. However, for this to happen, we need to be clear about the short-term threats that currently exist.

Along with all the fraudulent projects, rumors, and cults happening in cryptocurrencies, Tether is the most dangerous of them all, as it is being sold as a “real commodity” and could masquerade as the greatest Ponzi scheme of all time.

So here’s a refresher.

A quick look at the history of Tether
Bitcoin gained traction in 2010, and the idea of enabling other tokens to be built on top of the Bitcoin protocol began to take off (in fact, this was the original idea for Ether in 2014).

This gave birth to the Mastercoin project, whose vision was to address the two most important obstacles to large-scale Bitcoin adoption – insecurity and instability.

As a result, Mastercoin has been credited by some with “inventing the ICO” space. By 2015, Mastercoin will be renamed Omni.

The renamed Omni protocol will serve as the foundation for Tether, which is built on top of that protocol (Tether is also an ERC20 token – built on top of the ethereum blockchain protocol). Meanwhile, Tether was initially known as “Realcoin” before being renamed to Tether in 2014.

As its website explains, today “Tether tokens exist as digital tokens built on the Bitcoin (Omni and Liquid protocols), Ether, EOS, Tron, Algorand, SLP, and OMG blockchains.”

Further explaining, “Tether platform tokens are 100% backed by Tether’s reserves. Tether tokens are convertible in accordance with Tether Limited’s terms of service. The conversion rate is 1 Tether USDT token (USDT) equals 1 USD.”

Tether has had a clear mission from the beginning to facilitate trading in digital currencies by offering what is known as a stablecoin. A stablecoin itself is a digital currency that is tied to an underlying asset. In the case of Tether, this is the U.S. dollar.

So by pegging Tether to the U.S. dollar, anyone who converts their cryptocurrency back to a stablecoin has the advantage of being able to trade between various digital assets. They can do this without the dramatic price fluctuations that are inherent in the crypto world.

In short, stablecoins have become liquidity providers, especially for centralized exchanges. As liquidity providers, these currencies are just as good as exchanges accepting them as liquidity reserves.

There are several types of stablecoins, such as the top three Tether, USD Coin, and Binance USD, which are approaching $100 billion in market cap.

These stablecoins have all become so popular that at this point there is no real conversion between Bitcoin and USD, but rather the convention between Bitcoin and USDT (short for Tether) has been widely adopted.

This implication is important because it implies that there is no bitcoin liquidity in fiat currencies (i.e. you can’t really convert all existing bitcoins back to USD – at least not those that go through centralized exchanges). Again, this poses a serious systemic risk, as in the short term a massive liquidity shortage could easily occur if a large amount of USDT is converted to USD.

In fact, while some may argue that “hey, Tether’s market cap is just over $60 billion when Bitcoin is over $600 billion,” that argument is illogical. However, that argument is illogical. Because if there were a liquidity crisis, there’s no telling what the price of Bitcoin (and all other cryptocurrencies) would fall to.

Tether: A Token for Centralized Exchanges
What’s driving the mass adoption of stablecoins, and Tether in particular?

When people can easily exchange stablecoins for U.S. dollars, it gives traders no reason not to use them, and there are multiple reasons for this phenomenon. However, the incentives of centralized trading platforms have largely driven the adoption of stablecoins.

One of the benefits of stablecoins is the low intermediary fees required when trading.

The second reason why stablecoins are the preferred digital currency for investors is that some centralized exchanges have started to just accept them. According to the paper “WHAT KEEPS STABLECOINS STABLE?”, cryptocurrency exchanges such as Binance and Poloniex began accepting stablecoins as a medium of exchange back in 2019.

This means that the “liquidity” of these exchanges is regulated by stablecoins (this implication is important because it allows us to redefine what liquidity means on these exchanges and how it can be easily increased).

This brings us back to one of the core problems with Tether. Because its core assumption is that in a mass liquidation scenario, Tether can still redeem RMB while maintaining an exchange rate with the USD. The key problem here is that this exchange rate system is not going to be maintained.

But even worse, a liquidity shortage problem could have a huge negative domino effect on the entire crypto economy. So how does liquidity on centralized exchanges work?

How does centralized exchange liquidity work?
Ironically, centralized exchanges were one of the first viable business models built on Bitcoin. It’s a paradox that, as the saying goes, “not your private key, not your token” which means you don’t need anyone to hold your private key for you.

Nevertheless, “we keep your private key” has been the main business model of exchanges like Coinbase. Over the past decade, the crypto community has learned a hard lesson with the bankruptcy of many centralized exchanges (most notably Mt. Gox in 2014).

So, what makes this centralized exchange business model successful? Because it allows more and more people to participate without those users having to worry about wallets, storage and more complications.

You sign up for a site like Coinbase, which has a clean user interface and a gamified section (the platform allows you to earn bitcoins by completing a few basic questions), which gives you a great experience under the hood, so much so that you feel like an expert already.

By using the tagline “You don’t have to worry about your private keys”, centralized exchanges have significantly increased their user base and have become very profitable to run as the price of most cryptocurrencies has risen.

In the first quarter of 2021, platforms like Coinbase saw their revenue grow nearly tenfold, from $179 million to $1.59 billion. The entire business model of centralized exchanges is based on trading volume, as they make money primarily through transaction fees.

As a result, centralized exchanges have done wonders in the crypto market by easily expanding their user base.

They used a shortcut to solve the liquidity problem: stablecoins.

Back to Tether
Why Stablecoins Solve the Liquidity Problem, but Introduce Other Serious Systemic Risks

In a 2018 article titled “Why Stablecoins Make No Sense,” Tether was called a “childish stablecoin” because it was not introduced as a standalone currency. Instead, it’s more like a banknote or a promise of payment, which tells you that if you want to convert USDT (Tether) to USD, it will be easy to get backed.

But there is a problem here, because what makes a bill valuable is the degree to which you can trust the bearer. It is worth noting that the bearer of Tether is a private company called Bitfinex.

This is why 2021 is a pivotal year for decentralized exchanges (DEX). As Decrypto puts it, “allowing exchanges to exchange tokens without relying on buyers and sellers to create liquidity.”

Currently, DEX is dealing with certain fundamental problems (such as so-called “carpet pulling,” which is one of the most difficult problems of a decentralized platform that is not governed by any center).

In short, centralized exchanges use stablecoins to solve short-term liquidity (one of the biggest problems with cryptocurrencies), but they also create a host of problems, especially with Tether. At the most basic level, they simply require investors to trust the bearer, thereby centralizing the system and killing the entire premise of a blockchain-based system.

The situation only gets worse when the bearer is a private company that lacks transparency.

Let’s get started into Bitfinex.

Bitfinex Overview

Bitfinex is a very popular centralized exchange (because of Tether), making it among the top 5 centralized exchanges.

It is based in Hong Kong at iFinex Inc. and Tether is mainly issued by a company called Tether Limited, which is owned by the same owner of Bitfinex.

So what’s the problem?

Let’s start by looking at the red flags that make it difficult for holders to trust.

Of course, the assumption is that a “blockchain economy” is perfectly possible on these stable coins backed by unregulated private companies. So, if we want a system driven by a central exchange and stablecoin, we need regulation.

The first red flag: the lie of a 1:1 anchor to the dollar
Back in 2018, Bitfinex was accused of hiding $850 million in funds disguised as Tether reserves.

As the New York Attorney General put it, “Bitfinex and Tether recklessly and illegally covered up massive financial losses to maintain their scheme and protect their bottom line,”

Attorney General James continued, “Tether’s claim that its virtual currency was always backed by the U.S. dollar is a lie. These companies mask the real risks to investors by being run by unlicensed, unregulated individuals and entities that trade in the darkest corners of the financial system. The resolution makes clear that those who trade virtual currencies in New York State believe they can circumvent our laws. Last week, we sued to shut down Coinseed’s fraudulent practices. This week, we are taking action to end the illegal activities of Bitfinex and Tether in New York. These legal actions send a clear message that we will resist corporate greed, whether it comes from traditional banks, virtual currency trading platforms, or any other type of financial institution.”

Thus it can be concluded that

The deal struck today forces Bitfinex and Tether to cease all transactions with New York residents. In addition, to ensure compliance with this restriction, these companies must submit monthly reports to the OAG.

This example already raises significant questions about Tether’s suitability as a stablecoin, and we are in an era where size remains limited to less than $1 billion.

Today’s agreement forces Bitfinex and Tether to cease all transactions with New York residents. In addition, to ensure compliance with this ban, these companies must submit monthly reports to the OAG. This case has raised concerns about Tether as a stablecoin, which could have been avoided in the era we live in, as the size is still limited to less than $1 billion. Back in 2018, an article in the New York Times also claimed that the bitcoin price was manipulated by Tether in 2017.

Again, even if there is only a suspicion that this could be true, it is a serious problem for all of the crypto world.

Second Red Flag: Holding Huge Amounts of Commercial Paper

Tether (USDT) and the Cryptocurrency Ice Age

Source: Tether

Tether was first launched in March 2021, and now it has grown into a behemoth.

As the FT points out, while Tether claims to have 3.87% of its cash reserves, it also has a large commercial paper reserve that drives its global dominance.

As such, the most worrisome part of this study is the commercial paper backing, which represents Tether’s most significant backing.

According to Coindesk, commercial paper is a form of corporate debt that can be readily converted to cash or not, depending largely on the issuer and market conditions.

Coindesk further noted that Tether declined to disclose the names of the debtors or collateral for the loans.”

Thus, there are still many questions to be answered.

The third red flag: Tether money printing

In a post on Twitter by Nassim Nicholas Taleb and Paul Santos, Paul Santos highlighted two very important points.

Bitcoin’s price action is dominated by the Tether trading pair BTC/USDT, not BTC/USD, check the volume chart. Tether is BTC even if you have never traded Tether.

The exchange lacks liquidity. They all shut down at the same time when the market collapses and the outflow of dollars needs to be stopped.

Taleb replied, “If correct, it could effectively print Tether.”

If this is correct, it means that like central banks, Tether is creating money to inject short-term liquidity into the economy (thus aiding speculation), but there is a private company behind it, and we know very little about this private company, if not the recent collapse they have provided.

Imagine how you would feel if the entire financial system was built on a foundation that promised you “I promise I’ll pay you back” but then showed you a wallet full of toilet paper.

Key Takeaways
By expanding their user base of investors, centralized exchanges have become a major driver of the crypto economy with the tagline “You don’t have to worry about your private keys”. Since most banks still consider cryptocurrencies to be highly risky, no or few traditional banks are willing to do business with these exchanges.

This has led to the emergence of a solution to the short-term liquidity problems faced by these centralized exchanges: stablecoins.

Essentially, stablecoins are crypto versions of paper money in which holders can maintain a stable peg between the digital currency and an underlying asset such as the U.S. dollar, and the popularity of these stablecoins depends on the willingness of central exchanges to accept them.

Stablecoins have proven very successful in 2021 because they allow investors to avoid paying higher intermediary fees. It allows people to convert them to other digital currencies at any time, but this also poses a huge systemic risk. In short, BTC/Tether hooks are probably a large part of Bitcoin’s liquidity.

In short, if you want to convert bitcoin back to USD, you must first go through USDT (Tether). If Tether is not backed by actual dollars, there is no liquidity at all.

Worse, if there is a liquidity outflow, the entire crypto industry could be overwhelmed. What happens if there is no central authority to bail out the system? It’s worth thinking about.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/tether-usdt-and-the-cryptocurrency-ice-age/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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