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Tether Maintains Stable Price via Arbitrage

Tether (USDT) is a leading stable coin, with a total circulation of 2.826 billion USDT, each being worth roughly USD 1, as of this writing on 22 August 2018. The number of USDT in circulation has skyrocketed by billions of USD in the past year and continues to rise, as it’s become a good alternative to USD on exchanges where USD is not available.

Each USDT is backed by USD in a bank account, as can be seen on Tether’s transparency page. There was some debate as to whether Tether was printing currency and not really holding USD in reserve to back each USDT, but that speculation has mostly been squashed by a review of Tether’s reserves by one of the most prestigious law firms in the United States. This article explores how Tether maintains a price of almost exactly USD 1 all the time.

When looking at the long-term Tether price chart, it maintains a price of USD 1 almost all the time, deviating about 1 cent in either direction sporadically. During April and May 2018, Tether went down to USD 0.91 and then rose to USD 1.05, but other than this incident Tether’s price is stable at USD 1.

According to the laws of supply and demand this seems somewhat strange, since even if a cryptocurrency is backed by USD reserves, it should still fluctuate as demand fluctuates. In other words, just because a cryptocurrency is tied to a commodity or USD doesn’t mean it would stay at the price of what backs it unless there were mechanisms in place to keep the price steady.

An intrinsic stabilizing mechanism of USD₮ is that it is accepted at a value of USD 1 on exchanges around the world. If Tether’s price goes above USD 1, let’s say to USD 1.01 on an exchange, traders would move USDT from an exchange where the price is still at USD 1, and sell as much Tether as possible until the price goes back to USD 1. Likewise, if Tether is at USD 0.99 on an exchange, traders will buy as much as possible until Tether’s price goes back to USD 1. This is called arbitrage, and it is quite easy with Tether since it has no transaction fees. USDT can be redeemed for actual USD via Tether itself, or exchanges like Kraken, so that gives arbitrage traders an excellent option for cashing out profits if they catch Tether below USD 1.

There has been speculation on the internet that Tether itself stabilizes the price by selling USDT when the price rises above USD 1, and buying when the price drops below USD 1. They can do this by actively monitoring exchanges where it is traded, and keep a reserve of USD on each exchange for stabilization purposes. This is effectively the same as arbitrage, except easier since Tether already has the money in place and would probably beat other arbitrage traders to the punch.

Essentially, USDT is stabilized via arbitrage no matter how you look at it. It is so widely accepted that each should equal USD 1, especially since they can be redeemed for USD at parity from Tether’s cash reserves, that arbitrage traders across the world and perhaps Tether itself will jump on any opportunity to make arbitrage profits via USDT. This naturally keeps the price at parity with the USD long term. 

 

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