The Tether Crash of 2018
The USD pegged cryptocurrency has crashed and prices soared….
Why isn’t Tether worth a dollar anymore? How did this happen? And why the hell are crypto prices rising!? First of all, I don’t think anyone ever thought they would write that byline: “Tether tanks, bitcoin… moons?” If you spend any time in Discord or Telegram chatrooms discussing crypto’s future as it relates to the doom of Tether, this was not what you expected. We’re gonna talk very briefly about why Tether can be worth less than a dollar and, a little bit later, why Bitcoin prices increased and could continue to increase, when Tether struggles at under a dollar.
Tether is Worthless
Did I write that correctly? Worth less. Worthless? I’m pretty sure I got that right. So, the story of Tether is that, though there is no evidence to suggest this to be true, for every $1 of USD in the Tether bank account, there is 1UDST issued into the market place. Because of this arrangement, Tether is said to be “pegged” to the US Dollar. That is to say because of the fact that Tether is backed at a 1:1 ratio by US Dollars, Tether then, by all conventions, should be worth a dollar as well. I won’t insult you with further clever explanations about the inner workings of Tether. If you’re reading this, you probably already know all about it. If everything works like it should 1USDT = 1USD and then Bitcoin will then equal the same price when paired with either.
But, is Tether worth a dollar? No. Tether is worth what someone will pay you for it. Now, when Tether came on the scene, it filled a market need. That is, it provided an escape from volatility on unregulated exchanges where central bank issued currency was not accepted: a real market need in crypto and a noble idea. Too bad we have no evidence that Tether is backed by anything beyond claims from a Twitter account and a lousy, very uninformative, infrequently updated website. But moving on!
At the end of the day, if we all collectively believe that Tether is worth a buck. Guess what …. it is. Fortunately for Tether participants, at a basic level that’s how markets work. However, since Tether is traded on open exchanges, the dynamics do get a bit trickier than that. But lets face it, in the absence of any evidence of there being a Tether bank account with USD in it, having Tether traded on an exchange is the only thing that can otherwise validate its value. But how does that work? Essentially the way Tether remains worth $1 on an exchange is that the liquidity in the order book keeps it that way. I’m speaking about orderbooks of the USDT/USD pair. (BTW: Kraken is the exchange to keep your eye on as they are one of the only places for true USDT to USD conversion. There are other exchanges you can look at but we’ll center up on Kraken for simplicity’s sake)
So, on an exchange, price moves because of agreements between buyers and sellers as they are matched in the orderbook. Since Tether is designed to be a stablecoin pegged to the dollar, would you pay $1.50 for it? No, it has no value outside of its dollar backing so paying any more than $1 makes no sense. What about less than $1. Well, that might be an attractive offer, but who is going to sell you a Tether for less that $1 when they know it should be worth $1. See, market expectations are setting the price. What’s left? Well we have to be sure that there are buyers and sellers on both sides of the $1 mark in the orderbooks to satisfy those market expectations.
We need a thick orderbook on both sides of the bid and offer to handle the orders from everyone who wants to buy a USDT with a USD and everyone who wants to sell a USDT for a USD. If there are no USDT limit sell orders sitting on the order book and someone and someone comes on to Kraken to buy USDT what happens? Well, they wouldn’t be able to buy a USDT.... but, if there were limit sell orders at say $1.10 they would have to spend $1.10 (more than $1) for the USDT. Conversely, what happens if there is not a wall of limit buy orders at $1? Exactly. If someone comes to sell their USDT tokens they will end up selling their USDT tokens for less than $1. What this means is that the exchange needs to have sufficient liquidity to handle Tether buy and sell demand on the exchange. They keep Tether at $1 by having the exchange or liquidity providers place large limit orders on either side of that $1 level. Of course, retail guys, buyers and sellers can hop in the mix too with the liquidity providers and get filled.
Side Note: there’s a supply/demand curve discussion that can be had here. Understand, there are situations where someone wants to buy USDT at more than a dollar, such as a time sensitive opportunity, impatience or collapse of exchange (see USDT/USD chart on Wex via TradingView). There are also situations where you would be willing to sell your USDT for less than a dollar (e.g. it’s worth $0.95 now, it might be worth $0.50 tomorrow) This is a topic in and of itself, so we’ll leave that there.
Back to the topic at hand: What we have here is a failure of liquidity. The market sells are being slammed hard and as a result Kraken is handing over its USD for USDT tokens. The problem for them is that the sellers of USDT are destroying their buy walls. At the time of writing, there are 325,000 USDT buy orders from the present price $0.9537 to $0.95. This means for the low low price of $325,000USDT, you can be the proud owner of $308,750USD (estimated, because lets be real.. this number is probably already different in the time it took me to write this sentence.) Now $325,000 is a big number, but obviously when you have players like Binance who do $616M in Bitcoin volume alone in 24 hours (at a time when volume is at an all-time low), $325,000 is a drop in the bucket. Hell, if people sold 616M worth of Tether into USD on Kraken right now, the slippage would send USDT to $0.00.
Now, I’ll point out is there is a manipulative aspect to this. Is the liquidity not there because Kraken doesn’t have it? Probably not. But if they let the price slip to $0.95 what happens to the sell volume? It dies doesn’t it? There will be market participants who are not going to sell their Tether for less than $1. So, allowing the slippage in price also slows the rate at which Kraken has to give up its USD for USDT. Also, that $0.05 differential becomes a premium paid to the liquidity provider as well. If you sell your USDT to them for $0.95USD, Kraken just made $0.05 on that USDT when Tether goes back up to $1 and they resell it into the market. Oh yea, and don’t forget the fees. So, Kraken and their liquidity providers are going to be doing ok for themselves if Tether can pull through this. To their credit, they are taking the risk by buying your junk Tether. If they are purposely playing that game… god bless ‘em for chasing that alpha. But, even if not purposely, there is a payoff for their assumed risk. That’s fair.
So to recap, Tether remains worth a dollar because of two reasons: (1) Tether’s value is derived from the hope, dream and belief in leprechauns and unicorns that every USDT is back at 1:1 ratio with USD. and (2) Liquidity providers make sure that everyone who wants to buy or sell Tether for USD can do so at the exchange rate of roughtly 1USDT:1USD. As long as those two things stay in tact, Tether is worth a dollar. But, if that buy wall gets hammered hard enough and there’s no buyers for USDT at $1. Well, then Tether is exactly like every other exchange of value transaction on earth. It’s worth what someone will pay you for it.
…That’s all I have time for today. Part 2 will talk about why Bitcoin can moon when Tether tanks.
