The Tether Redemption Conundrum

In the early days of the United States, private banks were allowed to issue money on the condition that it was backed by gold. This meant that customers could redeem their specie and notes for gold, which was considered a stable medium of exchange in an economy rife with fraudsters and hucksters issuing fake money.

But a high redemption rate could eat into a bank’s operating costs or even bankrupt it. Therefore, it was important for such institutions to ensure wide circulation and minimize chances of redemption at the home institution.

And so, banks attached knotty conditions for redemption or fashioned partnerships with geographically distant financial institutions to make the process of redeeming their notes difficult and time consuming.

Longer circulation of their notes meant fewer redemptions and allowed banks to hold fractional reserves of the total amount in circulation. Or, in some cases, operate with a bare cupboard in the back, while they printed money and profits in the front.

Tether, the world’s biggest stablecoin by market capitalization, seems to be following a similar game plan. It is widely used across exchanges and has the highest trading volume among stablecoins.

But its reserves – the securities and cash backing the stablecoin – remain a mystery. Redeeming the stablecoin from its website is accompanied by significant conditions and costs. And very few exchanges support conversion of Tether to US dollar.   

The Indispensable Tether

Tether has become an indispensable part of the crypto ecosystem. It has a massive spread in cryptocurrencies: it is estimated to be available at 154 exchanges and trades across 17343 pairs. That spread makes the stablecoin critical to trader strategies.   

In a now-deleted video on the FTX YouTube channel, former CEO Sam Bankman-Fried is shown fretting about missed trading opportunities at Binance – the world’s biggest cryptocurrency exchange by trading volume – because he did not have enough Tether locked away there to conduct the trades.  

But holding Tether at exchanges is extremely risky for traders due to two reasons. First, the stablecoin may lose its peg to the US dollar and potentially convert a winning trade into a losing one. Second, like most of the crypto ecosystem, it functions outside the legal framework of most financial jurisdictions. This means it can easily be regulated out of existence.

Therefore, traders must exit their Tether trade as quickly as possible.

Where Must I Redeem Tether?

Traders and investors have two options to exit their Tether trade. The first is directly from its website. There, the barriers are many. The company charges 0.1 percent of the total amount as redemption fee, meaning it doesn’t maintain a 1:1 peg with the US dollar. Users also cannot redeem the stablecoin for amounts less than $100,000. U.S. retail investors are barred from buying or trading with Tether. Its website also lists conditions and risks that would make any investor run scared.

The second option to exit a Tether trade is at one of the numerous exchanges that boost its trading volume. [Whether those volumes are real, or a result of wash trading is open to question however]. Even here, there are multiple barriers.

Redeeming Tether at An Exchange

Very few exchanges support a direct trade between Tether and the US dollar. Theoretically, traders could cash out into Bitcoin or Ethereum – the top two coins – and convert them to fiat. But that transaction adds another layer of risk to the transaction because of the inherent price volatility of these coins.  

Tether’s trading volume against the US dollar in spot markets are a fraction of its overall volumes. For example, according to Coinmarketcap, a site owned by Binance, the top three trading pairs for Tether are Binance USD (BUSD), Bitcoin, and Ether and they account for roughly 20% of its overall volume, as of this writing. Binance does not offer a way into the US dollar using Tether.

American exchange Kraken is one of the places which offers this conversion. But that trade accounts for just 0.79% of the stablecoin’s overall volume. That percentage figure translates to $164 million, as of this writing. Because this is crypto, that figure is neither verified nor confirmed by neutral parties.

Incidentally, before it imploded last year, FTX also offered the USDT/USD pair. Even here, however, the pair accounted for a miniscule percentage of the stablecoin’s overall trading volumes.

Questionable Claims  

The complicated nature of Tether’s redemption calls into question its claims about redeeming investors.

Amidst the drama of crypto bankruptcies last year, the stablecoin claims to have processed redemptions worth billions of dollars in a matter of few days. Since exchanges supposedly account for a very small fraction of the trading volume against it, Tether must have processed most of these redemptions directly.

But it has not provided documentary proof or independent verification of its claims. It is easy to burn Tether tokens to reduce circulating supply and claim them as redemptions. Mere screenshots of online wallets stuffed with worthless tokens also do not count as proof. The company’s banking relationships could have provided a hint. But they are cloaked in lies and obfuscations.  

Talk of banks leads us to another question related to Tether’s redemptions.

Does the stablecoin reimburse exchanges that allow redemption of Tether into US dollars? If yes, that would mean Tether would need sufficient cash on hand, over and above its reserves, to process daily redemptions. There’s also the ancillary question of how such transactions are processed considering problems faced by cryptocurrency exchanges in developing banking relationships. But that’s a completely different post altogether.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.