The emergence of Bitcoin in 2009 fundamentally changed our traditional financial system. The first cryptocurrency gained value due to increasing demand rather than being backed by precious metals or a government's economic activity. Bitcoin (BTC) became a new type of currency independent of any country or financial institution.
Cryptocurrencies like Bitcoin suffer from one significant problem that makes them difficult for everyday use: high price volatility. The fluctuating value of digital currencies hinders their adoption as payment methods because people cannot be certain whether the coins used today will be more or less valuable in the future.
To address volatility risks, a new type of cryptocurrency emerged: stablecoins. These digital assets can be pegged to traditional currencies, precious metal values, or other cryptocurrencies. The vast majority of stablecoins are pegged to the US dollar, designed to replace traditional fiat dollars within the cryptocurrency ecosystem.
Today, numerous dollar-pegged stablecoins circulate in the market, with CoinMarketCap listing 31 such coins.
What Is USD?
USD stands for United States Dollar, the national currency of the United States and the world's primary reserve currency. Most international transactions occur in USD, and Bitcoin's value on most cryptocurrency exchanges is displayed in US dollars.
USD isn't backed by commodities or precious metals. The dollar's value is maintained through supply and demand balance. The Federal Reserve System (Fed) controls dollar emission, increasing or decreasing currency issuance based on monetary policy. For example, during the past two years of pandemic response, dollar emission doubled.
Most global transactions occur in US dollars, requiring banking intermediaries to facilitate USD transfers. These financial institutions charge fees for their services, and international interbank transactions can take several days. Banks may also request documentation explaining and confirming transactions, and they can reject transfers if they suspect illegality or non-compliance.
Additionally, sanction risks exist where USD transfers can be blocked for certain individuals or territories. Several Russian banks currently cannot process foreign currency transfers due to sanctions and disconnection from the SWIFT international payment system.
What Is USDT?
Today, USDT is the largest traditional stablecoin by market capitalization, backed by fiat US dollars. Its total circulation exceeds $66 billion.
Issued by Hong Kong-based company Tether, this stablecoin began as Realcoin in July 2014 before rebranding to USDT in November of the same year. The project initially operated on the Omni Layer protocol built on Bitcoin's blockchain, enabling exchange between USDT and Bitcoin.
The first USDT tokens circulated on the Bitfinex cryptocurrency exchange. Today, this major stablecoin is available on nearly all digital trading platforms in trading pairs with other cryptocurrencies.
Tether USD's initial success made it extremely popular for exchanging Bitcoin for US dollars and vice versa, increasing demand for the coin. Consequently, Tether expanded USDT to other blockchains including Ethereum, Tron, EOS, Algorand, and Solana.
USDT Issuance, Circulation, and Redemption
The stablecoin maintains a 1:1 peg to the US dollar, holding equivalent USD reserves to the number of USDT in circulation. The process of issuance, circulation, and redemption is detailed in Tether Limited's Whitepaper and consists of five steps.
First, institutional investors such as cryptocurrency exchanges deposit US dollars into Tether's bank account and receive newly minted USDT in return.
Second, the newly created USDT tokens are deposited on the Bitfinex cryptocurrency exchange, where investors who previously deposited US dollars can receive minted USDT into their cryptocurrency wallets.
The third stage involves actual USDT circulation in cryptocurrency operations. It can be used for transfers between users or for purchasing other cryptocurrencies.
The fourth step involves institutional investors depositing USDT into Tether's cryptocurrency wallet.
On the fifth step, investors receive fiat US dollars in their bank accounts in exchange for deposited USDT, while the submitted USDT tokens are removed from the blockchain and burned.
Only institutional investors can access the USDT issuance and redemption process. Ordinary individuals cannot send US dollars to Tether Limited to mint USDT. Similarly, individuals cannot exchange their USDT for US dollars through Tether's treasury.
Theoretically, this process means Tether's reserves contain 1 US dollar for every 1 USDT in circulation.
Primary Use Cases for USDT
USDT serves multiple purposes, with these being the most popular applications.
Trading
The primary purpose of USDT issuance is for trading pairs on cryptocurrency markets. Since it maintains its value over time, users can store it in cryptocurrency wallets for extended periods without depreciation risk.
Using USDT represents the simplest way to buy and sell cryptocurrencies. As it's equivalent to the US dollar, traders utilize USDT for trading operations. Exchanging Bitcoin for USDT is faster than converting to US dollars because USDT already exists on the blockchain, while US dollars reside in the traditional financial system.
Savings
A popular use case for USDT, particularly in developing countries suffering from inflation, is savings preservation. Purchasing USDT with local currency equates to buying US dollars. Thus, savings can be protected from inflation, and owners can access them faster and easier than through traditional banking systems.
Investing
USDT is also one of the most commonly used assets on money markets and cryptocurrency savings protocols like Aave and Compound. By depositing USDT on these platforms, investors can earn up to 10% annual interest or higher.
Transfers
Since USDT equates to US dollars, many people use it instead of USD. USDT owners can perform any cross-border operations with it. In many cases, sending USDT is significantly cheaper than using traditional international transfer systems like Western Union or MoneyGram.
International Trade
USDT can replace US dollars in international settlements because operations with it are less complex and costly, requiring no banking intermediaries. More organizations are accepting cryptocurrency as payment. As of June 22, 2022, nearly 30,000 merchants worldwide accept cryptocurrency payments.
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Key Differences Between USD and USDT
The main distinctions between USD and USDT are presented in the following comparison:
| Aspect | USD | USDT |
|---|---|---|
| Application | Global, potentially restrictable | Global, hypothetically unrestricted |
| Emission | Centralized by monetary authority | Centralized on decentralized blockchain |
| Issuance Form | Cash and cashless | Digital |
| Reserve Backing | Not reserve-backed | Backed by US dollars |
| Usage Restrictions | Applicable to individuals and states | Not applicable when stored in crypto wallets, but possible on centralized exchanges |
| Counterfeiting | Possible | Impossible |
| Transfer Costs | High, charged by banks | Low |
| Transfer Speed | Up to several days | Up to several minutes |
Centralization
Like any fiat currency, the US dollar is regulated by a centralized monetary authority—the US Federal Reserve System. It determines emission volume by setting interest rates for various financial instruments. Additionally, the US government regulates which financial institutions access USD and controls counterfeit bill circulation.
Despite being issued on blockchain, USDT represents a hybrid of centralized and decentralized assets.
USDT issuance and redemption are centralized because all existing US dollar reserves backing USDT are stored in a single Hong Kong financial institution, with emission controlled by Tether Limited.
After emission, USDT becomes decentralized as it uses blockchain for transactions. Once issued, Tether Limited no longer controls it, and anyone with a cryptocurrency wallet can purchase it.
Acceptability
The US dollar is the most widespread form of fiat money globally. Nearly all international operations occur in US dollars, and many national banks maintain significant dollar reserves for foreign trade.
Similarly, USDT is the most used stablecoin. It plays a vital role in cryptocurrency transactions by enabling users to buy and sell digital currencies for a stable asset.
Beyond exchange operations, USDT serves other purposes like trading and money transfers.
Financial System Foundation
The US dollar forms the foundation of the SWIFT banking system and global commodity trade. When someone sends an international bank transfer, the currency typically converts to US dollars before reaching its destination.
USDT has become the foundation of crypto-economics because it enables rapid cryptocurrency exchange and provides a secure storage method for digital assets without volatility exposure.
USDT vs USDC: Which Is Better?
The second-largest stablecoin by capitalization is USDC. Its issuance, circulation, and redemption procedures resemble USDT's, with over $55 billion USDC in circulation.
The Centre consortium issues USDC, founded by American companies Circle Internet Financial Ltd. (CIF) and Coinbase cryptocurrency exchange. The stablecoin's founders operating under US jurisdiction, combined with Coinbase's recent stock exchange listing, implies comprehensive financial auditing by both regulators and independent auditors. This increases investor confidence in reports disclosing USDC's reserve backing.
Meanwhile, cryptocurrency users and analysts have numerous concerns regarding USDT's reserve security. Tether Limited, operating under Hong Kong jurisdiction, discloses that portion of its reserves are held in commercial securities. Given falling prices of many financial assets, risks exist that some reserves have depreciated, making their actual volume insufficient to back circulated USDT.
These concerns intensified when the largest algorithmic stablecoin UST lost its dollar peg in early May. The key difference between UST and USDT lies in their dollar peg mechanisms. UST lacked reserve backing, maintaining its dollar parity through an algorithm involving issuance and redemption of its linked cryptocurrency LUNA.
This peg mechanism couldn't withstand high seller pressure, causing UST to lose its dollar peg and drop from $1 to $0.01 quickly. Its linked cryptocurrency LUNA lost all value, declining from $85 to $0.00001.
Cryptocurrency investors' concerns about USDT's ability to maintain its dollar peg are growing. Confidence in USDT's reserve backing is decreasing, while USDC's reserve backing remains unquestioned.
Consequently, holders are moving from USDT to USDC. Since early May, USDT's capitalization dropped from $83 billion to $67 billion, while USDC's capitalization grew from $48.5 billion to $56 billion during the same period. Thus, USDC is increasingly becoming the more reliable and in-demand stablecoin.
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Frequently Asked Questions
Why is USDT pegged to the dollar?
USDT (Tether) is a stablecoin pegged 1:1 to the US dollar. This peg provides stability for cryptocurrency transactions, reduces volatility, and facilitates convenient settlements. The peg is maintained by holding equivalent reserves in fiat currency or other assets.
What backs USDT and USDC?
USDT (Tether) is backed by reserves including cash, bonds, and other assets. Although Tether claims 1:1 backing, questions remain about reserve transparency. USDC (USD Coin), developed by Circle, is fully backed by verified US dollar reserves or equivalents. USDC is currently considered more reliable due to regular independent audits confirming reserve adequacy.
Is USDT a stablecoin?
Yes, USDT is a stablecoin that maintains a stable value of approximately $1. The primary purpose of stablecoins is providing stability in cryptocurrency markets and liquidity for exchange trading and asset conversions. USDT and USDC are among the most popular stablecoins actively used by traders and investors.
Which blockchains support USDT and USDC?
Both tokens operate on multiple blockchains. USDT supports Ethereum (ERC-20), Tron (TRC-20), Bitcoin (Omni Layer), Binance Smart Chain, and others. USDC operates on Ethereum (ERC-20), Solana, Polygon, Avalanche, and other networks. This versatility enables transactions across different networks, with blockchain choice depending on transaction fees and speed requirements.
Can individuals redeem USDT for USD directly?
No, ordinary users cannot directly redeem USDT for US dollars through Tether Limited. Only institutional investors and authorized partners can participate in the redemption process. Individual users must use cryptocurrency exchanges or other platforms to convert USDT to fiat currency.
What are the risks of holding USDT?
The primary risks include potential reserve inadequacy, regulatory challenges, and loss of dollar peg. While Tether claims full backing, concerns about reserve composition and transparency persist. Regulatory changes could impact USDT's availability on exchanges, and market conditions could temporarily affect its peg stability, though it has historically maintained its dollar value.