The tether price displayed on the Kraken cryptocurrency exchange website.
Tiffany Hagler | Bloomberg via Getty Images
Tether is the third largest cryptocurrency in the world by market value. And some economists – including a Federal Reserve official – are concerned.
Last month, Boston Fed President Eric Rosengren raised the alarm about Tethers, calling it a potential risk to financial stability. Meanwhile, some investors believe that a loss of confidence in Tether could be crypto’s “black swan”, an unpredictable event that would severely affect the market.
The issues related to tether are having a significant impact on the nascent world of cryptocurrencies. And economists increasingly fear that it could also affect markets beyond digital currencies. Here’s what you need to know:
What is tether?
Chances are you’ve heard a thing or two about Bitcoin by now. But what about the string?
Like Bitcoin, Tether is a cryptocurrency. In fact, it is the third largest digital coin in the world by market value. But it is very different from Bitcoin and other virtual currencies.
Tether is a so-called stablecoin. These are digital currencies that are tied to real assets – the US dollar, for example – in order to maintain a stable value, unlike most cryptocurrencies which are known to be volatile. Bitcoin, for example, rose to an all-time high of nearly $ 65,000 in April and has almost halved in value since then.
Tether was designed to be pegged to the dollar. While other cryptocurrencies often fluctuate in value, the price of Tether is usually the equivalent of $ 1. That’s not always the case, however, and fluctuations in the value of Tether have scared investors in the past.
Crypto traders often use tether to buy cryptocurrencies as an alternative to the greenback. This essentially gives them an opportunity to seek security in a more stable asset during times of high volatility in the crypto market.
However, crypto is unregulated and many banks avoid doing business with digital forex exchanges because of the risk involved. This is where stablecoins tend to come into play.
Why is it controversial?
Some investors and economists are concerned that Tether’s issuer does not have enough dollar reserves to justify its dollar peg.
In May, Tether reduced the reserves for its stablecoin. The company announced that only a fraction of its holdings – 2.9% to be precise – was cash, while the vast majority was in commercial paper, a form of unsecured, short-term debt.
That would make Tether one of the top 10 largest commercial paper holders in the world, according to JPMorgan. Tether has been compared to traditional money market funds – but without any regulation.
With more than $ 60 billion worth of tokens in circulation, Tether has more deposits than many US banks.
There have long been concerns about using Tether to manipulate Bitcoin prices, with one study claiming the token was used to prop up Bitcoin during major price drops in its 2017 monster rally.
Earlier this year, the New York Attorney General reached an agreement with Tether and Bitfinex, an affiliated digital currency exchange.
The state’s top law enforcement officer had charged the companies with moving hundreds of millions of dollars to cover losses of $ 850 million.
Tether and Bitfinex agreed to pay $ 18.5 million in settlement and were banned from operating in New York state, but the companies did not admit any wrongdoing.
JPMorgan analysts previously warned that a sudden loss of confidence in Tether could result in a “severe liquidity shock to the broader cryptocurrency market.”
However, there are also concerns that a sudden surge in tether withdrawals could lead to potential market contagion affecting assets beyond crypto.
In June, Rosengren mentioned tether and other stablecoins as one of several potential risks to financial stability.
“These stablecoins are becoming increasingly popular,” he said during a presentation.
“A future crisis could easily be triggered as these become a more important sector of the financial market unless we start regulating them and making sure that what is being marketed to the public as stablecoin is actually much more stable,” added.
Last week, Fitch Ratings warned that a sudden mass redemption of tether tokens could destabilize short-term credit markets.
“Less risk comes from coins that are fully backed by safe, highly liquid assets, although authorities may still be concerned if the footprint is potentially global or systemic,” the US credit rating agency said.
“While stablecoins that use partial reserves or apply a riskier asset allocation can be exposed to greater risk of running.”
Tether is not the only stablecoin on the market, but it is by far the largest and most popular. Others are USD Coin and Binance USD.