Tether is one of those genius ideas that makes me jealous I didn't come up with it. In one swoop the principals solved:
- The "Oracle Problem" of connecting USD to the blockchain
- The problem of making themselves rich
Why is the "Oracle Problem" listed first? Because plenty of coin issuers have made themselves rich without doing anything useful or important.
What is it, exactly?
Tether is a cryptocurrency whose promise is that it is always worth a dollar.
Tether depends on two properties:
- The Tether Company pledges to redeem 1.00 USDT at any time for $1.00 USD.
- The Tether Company may print USDT. (And destroy USDT in their possession.)
There are a variety of ways to kick such a project off, but let's start with a simplification. Tether borrowed $40 million (let's say) from Hong Kong banks. Then they sold the same amount of USDT for $1USD each. That's it, they're set. If they want they can give the original money back to the banks. The sale proceeds are now float and Tether is a bank with 100% reserves.
How Do You Pin It to the Dollar?
- When USDT is at 1.01USD: Tether creates a new USDT and sells it for 1.01USD. They make a penny in profit, they get a dollar in float, and they incur 1.00 in obligations. The creation and sale of new USDT drives the price down towards 1.00USD.
- When USDT is at 0.99USD: Tether buys a USDT and destroys it. They save a penny repaying their obligations. The purchase and destruction of USDT drives the price up towards 1.00USD. Tether could also do nothing, in which case the market will purchase USDT in order to redeem it for a penny in profit.
This scheme is pretty darn airtight. Tether's profit motive keeps USDT at $1.00USD. This is an "approximation algorithm" to the problem of tethering USD to the blockchain, but it is a very good approximation. See the chart. The more USDT there is in circulation, the more stable it's going to be. And, for the foreseeable future, as long as USDT is working, demand, and hence the amount of USDT in circulation, is going to grow.
Yeah, but Nobody Would Have Loaned ME $40M
- Oh, yes they would have. Anybody who talked to the right people would've gotten this loan. You can actually structure it so that there is 0% risk to the investor. Kids get million dollar loans for far stupider ideas.
- You could ICO this without any starting capital: simply delay the renewal date or promise some future proceeds to the initial buyers.
Is Tether Safe?
Some have accused them of lying about the original loan. It looks legit to me, but the point is entirely moot. After the Tether "ICO", it doesn't matter whether they had the money or not: Their obligations are covered and they can operate as a bank.
Yeah, but what if they run away with my money?!
If you had a money printing press, would you do anything to endanger that fact? Trust in Tether works for the same reason trust in a bank works: there's too much money in staying legit. They could mismanage the company and go under, but so could any bank.
Where Does the Demand Come From?
It's a convenient way to park other crypto money in a less volatile place (e.g., during forks). Some have said such exchanges represent untaxed "like-kind" transactions, but I am not an accountant and don't know. Beyond that, these dollars have all the nice transfer properties of a cryptocurrency. But since it isn't actually a dollar, it's technically not regulated like dollars are (yet).
Update: Tether's ToS says they don't have to redeem my Tethers!
The whitepaper says:
Each tether unit issued into circulation is backed in a one-to-one ratio (i.e. one Tether USDT is one US dollar) by the corresponding fiat currency unit held in deposit by Hong Kong based Tether Limited. Tethers may be redeemable/exchangeable for the underlying fiat currency pursuant to Tether Limited’s terms of service or, if the holder prefers, the equivalent spot value in Bitcoin.
And the FAQ backs it up. This article isn't really about anything other than the Tether idea, and not how you might misuse it, so I'm tempted to leave it at that.
However, I can think of a lot of reasons why Tether would say something different in their ToS (but still plan to redeem USDT): regulatory reasons, money transmitter reasons, perhaps they just want powers above and beyond a bank... Believe it or not regular banks have their own set of tricks to stop bank runs.
Here's the deal. Only two things matter: 1. That USDT stays at or above a dollar. 2. If it doesn't, that Tether makes good on its promise to redeem USDT. The market is already taking care of #1, so conversation over for the time being. If that stops happening, and Tether doesn't make good on #2, then they would kill the goose and someone somewhere would find some way to throw them in jail. Why would you turn down a few claims when you have a billion dollars in float to cover it? They would have to be complete fools. But all the evidence shows these guys are very, very smart.