Yves here. I have a simpler way of coming to a conclusion similar to the one Barkley Rosser reaches below on Tether. Tether is meant to solve one of the big problem with Bitcoin and other cryptocurrencies that Nassim Nicholas Taleb identified in his recent paper on Bitcoin, that unless they have a stable relationship to a real world currency used for commerce, they’ll never become a medium of exchange.
For those who have managed not to hear of Tether, let us turn the mike over to Wikipedia:
Tether is a controversial cryptocurrency with tokens issued by Tether Limited, which in turn is controlled by the owners of Bitfinex. Tether Limited formerly falsely claimed that each token was backed by one United States dollar, but on 14 March 2019 changed the backing to include loans to affiliate companies. The Bitfinex exchange was the subject of a lawsuit by the New York Attorney General of using Tether’s funds to cover up $850 million in funds missing since mid-2018. The investigation found that iFinex — the operator of Bitfinex and Tether — made false statements about the backing of the Tether and about the movement of hundreds of millions of dollars between the two companies to cover up the truth about massive losses by Bitfinex. According to the New York Attorney General, “Tether’s claims that its virtual currency was fully backed by U.S. dollars at all times was a lie”.
Tether is called a stablecoin because it was originally designed to always be worth $1.00, maintaining $1.00 in reserves for each tether issued. Nevertheless, Tether Limited states that owners of tethers have no contractual right, other legal claims, or guarantee that tethers will be redeemed or exchanged for dollars. On 30 April 2019 Tether Limited’s lawyer claimed that each tether was backed by only $0.74 in cash and cash equivalents. In May 2021, Tether published a report showing that only 2.9% of Tether was backed by cash, with over 65% backed by commercial paper.
Tether Limited and the Tether cryptocurrency are controversial because of the company’s alleged role in manipulating the price of bitcoin, an unclear relationship with the Bitfinex exchange, and the company’s failure to provide a promised audit showing adequate reserves backing the Tether token.
In other words, Tether tries to make itself a vehicle that can be used in normal commerce by maintaining a very hard currency peg to the dollar. History shows currency pegs don’t work, even the famed gold standard. Countries cheated all the time by changing the gold price of their currency. Countries that have tied their currency to the dollar have either had unhappy results, aka debt or currency crises or both, or like China, have had to loosen the peg (to simplify a long and complicated story, China had to allow the renminbi to appreciate via a mechanism informally described as a dirty float).
By Barkley Rosser, Professor of Economics at James Madison University in Harrisonburg, Virginia. Originally published at EconoSpeak
I do not know, but there is a fairly serious argument now out there that this could happen. It is made by Gennaro at hackermoon.com/tether-and-the-great-crypto-ice-age-115h329k , picked up on by Tyler Cowen on Marginal Revolution without comment. Among those Gennaro cites at least partly supporting his argument are Nassim N. Taleb.
So the argument is that bitcoin and most other major cryptocurrencies are now fundamentally based on stablecoins tied to the US dollar, with claims those stablecoins can be easily traded into dollars. According to Gennaro, and I do not know if he is right, the various non-stablecoin cryptocurrencies now use stablecoins to trade between each other at low costs, with these stable coins providing liquidity, but at the cost of a dangerous potential instability. If there is a rush on them, they have no ultimate backer, and a crash by them could drag all of the cryptocurrencies into an ultimate total crash into an effectively zero absorption barrier, with Taleb apparently providing some support for this possible scenario.
As it is, Tether is now the leading stablecoin, indeed the #3 cryptocurrency overall, behind Bitcoin and Ethereum. According to Gennaro, the central fact of crypto trading is that the most important ratio is that between bitcoin and tether, not bitcoin and the dollar, although the latter is the ultimate measure of value, the de facto “gold” of the cryptocurrency markets, even as bitcoin itself has been claimed to the “new gold,” and gold has definitely become quite boring.
Again, according to Gennaro, a major problem with Tether is that while on the one hand it has essentially centralized Bitcoin trading into itself, if not all crypto trading. But unlike the dollar, which has the Fed to back it up, Tether has nothing. It is owned by a semi-murky Hong Kong based entity, Bitfinext, which has already been in legal trouble in the state of New York for misrepresenting and hiding certain transactions and assets. Gennaro argues this shows that it has no backing, and that a run on it will make it unable to access actual US dollars, the world’s actual key currency, which could lead to an implosion dragging down the entire cryptocurrency market, given the nonexistence of any entity capable of coming to its rescue.
For those who want to find this particular tale somewhere between laughable and unlikely, while Bitcoin, Ethereum, and several other leading cryptocurrencies have suffered major declines recently, driven by such things as the Chinese government imposing serious restrictions on their mining and use, the one cryptocurrency that has gained in the last week has been, oh yes, Tether. But then pride goeth before a fall,. While I am going to stay out of forecasting anything in these markets, given how many important market manipulators are playing in them, regarding whom I have no idea what they will do, it does seem that the possible volatility and more deeply threatening threats in them has increased.