At the height of the collapse of Terra’s infamous stablecoin known as UST, many investors panicked and started dumping other popular stablecoins like USDT, causing it to lose its $1 peg on quite a few occasions.
While the stablecoin has since returned to parity, there have been occasional incidences of it momentarily trading below the $1 peg, albeit only for an odd cent and is faring much better now than what it did in May, when it dipped to a low of $0.85 cents.
As many new crypto investors are still confused and concerned about USDT and UST, perhaps due to the similarity in their names (Tether vs Terra, USDT vs UST), or due to unsubstantiated rumours about USDT, we decided to summarise the situation for our readers so that they can put their worries to rest.
Who Manages These Stablecoins
USDT, the original and longest standing stablecoin, has been around since 2014. It is managed by Tether Limited, which is owned by a Hong Kong based company called iFinex Inc., which also owns the cryptocurrency exchange Bitfinex. As of July 2022, Tether Limited has minted the USDT stablecoin on ten different blockchains and has also issued stablecoins pegged to the Euro, other currencies and gold. However, USDT, the stablecoin pegged to the US dollar, is the most commonly used, and the name Tether has since been synonymous with USDT.
UST, on the other hand, was a first of its kind algorithmic stablecoin that was not backed by real world assets. Instead, it was backed by the demand of another cryptocurrency known as LUNA, and was issued by Terraform Labs, a Singapore based company.
UST was Backed By Hopium
Strange as it may sound, LUNA was the backing that would ensure that UST would always be $1. As such, UST was priced in LUNA and vice versa. LUNA was the native token that was used to run the Terra blockchain that UST was built on.
The Terra team would create use cases and generate publicity for LUNA so that demand for LUNA would increase. Everytime UST traded below $1, or if there were redemptions on UST, more LUNA tokens would be minted to buy up UST. If excess demand caused UST to trade above $1, more UST would be minted and sold to keep the price at $1, after which an equivalent amount of LUNA would be burned to compensate for the increased UST supply.
The team’s theory was that the burning of LUNA tokens would reduce its circulating supply and with it, increase investors’ demand for it due to the scarcity angle. One would not need a rocket scientist to know that such a flimsy model based on idealism was not going to last.
While things looked good at first during the crypto bull market and the price of LUNA was going up, the entire ecosystem collapsed when crypto prices started falling, as not enough new demand for LUNA could be created to meet the redemptions of UST. As a result, the price of LUNA started cratering in early May 2022.
As investor confidence started to wane and more redemptions hit UST, at least 9 times the supply of LUNA tokens were minted in a matter of days and sold in the market to help maintain UST’s price. This was a vicious cycle that killed both UST and LUNA since neither had buyers, they only had sellers.
Within days, both UST and LUNA crashed to zero and a rehabilitation plan had to be put in place to salvage what little was left of investors' monies.
USDT is Backed By Actual US Dollar Reserves
By comparison, USDT is a completely different animal. To maintain its peg, Tether holds an equivalent amount of US dollar reserves in cash equivalents like US Treasury bills. These holdings are now audited by BDO Italia, which regularly verifies the holdings and issues attestation reports on the amount of US dollar reserve.
Holders of USDT can redeem their USDT back into US dollars for $1 anytime they wish with Tether Limited. Tether Limited will simply return the US Dollar reserve that is tied to this redemption and remove the corresponding USDT from circulation. In other words, USDT works like an IOU that is issued by Tether Limited to USDT holders.
Why USDT Will Not End Up Like UST
No matter what happens to the US dollar, USDT will always be 1-1 with it due to its reserves. Even if the US Dollar were to lose value, USDT will still be $1. The only thing that could happen should the US dollar lose its value, would be that the price of other assets would have risen in tandem, i.e. in such a situation, the price of Bitcoin may become a lot higher, but the price of USDT will not change since it is a digital representation of the US dollar. Hence, it is rather impossible for USDT to end up the same way as UST.
Is USDT Risk Free Then?
That is not to say that USDT is not without risks. Since USDT is issued by Tether Limited, which is a private limited company, should the company wind up or file for bankruptcy, then those USDT may become unredeemable.
Over the years, skeptics have casted doubts about the amount of reserves Tether has to back up the 1-1 peg with the US dollar, while some others have cast doubts about the type of reserve asset that Tether is holding. Tether has also been sued several times by US lawmakers, but has always managed to settle the lawsuits without any admission of guilt.
The last lawsuit involved its official statement regarding its reserves. On October 15, 2021, Tether Limited paid a fine of $41.6 million for inaccurately claiming that its minted USDT were 100% backed by fiat US dollar, when in actual fact, their 100% backing was made up of a combination of fiat US dollar and other assets such as "unsecured receivables, commercial papers, funds held by third parties, and other non-fiat assets”.
The firm however, has since the incident, been cleaning up and improving on its transparency. Currently, the company publishes its reserves holdings and attestation reports on its website that is updated daily.
As far as we are aware, Tether no longer has any outstanding lawsuit as at the time of writing.
Screenshot from tether.io website
Further to this, Tether’s CTO, Paolo Ardoino, has been regularly appearing on Twitter to post about the financial condition and reserve mix of Tether. Ardoino’s latest tweet on October 3 states that as of September 30, the company has increased its US Treasury holdings to 58.1% of its total portfolio from 43.5% in June, and has cut its commercial paper holdings to less than $50 million. Tether had promised to bring its commercial paper holdings to zero by the end of this year to pacify user concerns over the risk and liquidity issues of investing in commercial paper.
Commercial paper is short-term unsecured debt issued by companies, which is less stable than government issued debt instruments like the US Treasury bonds.
While we cannot deny that USDT does have its risks, the company is showing a willingness to improve and appease user concerns, and certainly is in no way similar to UST and Terra at all.
We hope our short summary above can be of help to our readers in clarifying their concerns.