Explained in One Article | Will USDT Tether be the Biggest Bombshell in the Cryptocurrency Community?

Author: Lawyer Liu Honglin

A few days ago, in the article “People in the Crypto Circle, Please Eat Watermelon Correctly: Hubei Police Crack the First “Virtual Currency Case” in the Country, with a Transaction Volume of 400 Billion!”, Lawyer Honglin took everyone to eat a small watermelon about USDT. From the explosive comments section, it can be seen that everyone enjoyed eating this watermelon, and many friends were even shocked.

In fact, this is not surprising at all. People think that the virtual currency they are playing with is decentralized, but they should know that there are many well-known institutions in the crypto circle that cooperate with the police.

As a global company, Tether has established a mechanism of on-chain blacklists and a close and friendly cooperative relationship with law enforcement agencies around the world in order to fulfill its anti-money laundering compliance obligations. Whenever law enforcement agencies require it and believe that funds are involved in fraudulent activities, money laundering, or terrorist financing, it will restrict the related addresses. The principle of “freezing” lies in the fact that as an intelligent contract programming product, USDT can use code to restrict the EOA’s management authority over the token. When a certain address is “Added to the Blacklist” by the centralized Tether company, it can no longer transfer the USDT tokens in that address.

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As of March 2023, Tether has blacklisted 846 addresses in the Ethereum network, freezing more than 449 million USDT.

In this article, as a follow-up to the watermelon-eating article, I would like to share more stories about USDT with you. The content of the article is a bit long, roughly in several parts:

– Background and development history of USDT – Technical architecture and operation mechanism of USDT – Challenges and risks faced by USDT – The awkward situation of USDT in China

Introduction to USDT

USDT, also known as Tether, is a type of cryptocurrency that is pegged to the value of the US dollar. Each USDT is equivalent to one US dollar, so it is also known as a stablecoin.

The goal of USDT is to provide a stable value anchor for the cryptocurrency market, allowing users to easily exchange between different cryptocurrencies or between cryptocurrencies and fiat currencies.

The issuance of USDT is controlled by Tether Limited, a company affiliated with Hong Kong-based iFinex, which also owns the Bitfinex cryptocurrency exchange.

According to data from the CoinMarketCap website, as of July 4, 2022, the total supply of USDT is 66,081,540,012.39 tokens, with a total market capitalization of 66,081,540,012.39 US dollars, ranking third among all cryptocurrencies, second only to Bitcoin and Ethereum. The 24-hour trading volume of USDT is 72,038,000,000.00 US dollars, ranking first among all cryptocurrencies. USDT is traded on over 400 exchanges and platforms worldwide, and supports more than 10 different blockchain protocols.

The Birth and Development of USDT

In 2014, when cryptocurrencies like Bitcoin had already gained widespread attention, they also faced several issues, including:

• Volatility in prices. The cryptocurrency market had no price limits, resulting in significant price fluctuations and high risks for investors. For example, in November 2013, the price of Bitcoin surged from $200 to $1,200, only to fall to $800 in January 2014. In December 2017, the price of Bitcoin increased from $10,000 to $20,000, but then dropped to $6,000 in February 2018.

• Inconvenience in fiat currency exchange. Many cryptocurrencies lacked direct channels for fiat currency exchange, requiring conversion to mainstream cryptocurrencies like Bitcoin before being exchanged for fiat currency. This process was time-consuming, costly, and involved exchange rate risks and transaction fees.

• Lack of regulatory clarity. Different countries had inconsistent attitudes and policies towards cryptocurrencies, with some prohibiting or restricting their use and trading, while others were more open or tacitly approved. This brought significant uncertainty and compliance challenges to the cryptocurrency market.

To address these issues, Tether introduced a stablecoin called USDT. It aimed to leverage the advantages of decentralized, peer-to-peer, low-cost, and efficient blockchain technology, while adding features such as pegging to fiat currency, maintaining price stability, and providing channels for fiat currency exchange to meet market demands.

• In 2014, Tether was established and began planning the issuance of USDT. At that time, the digital currency market was still in its early stages and lacked a stable trading medium. Tether believed that by issuing a stablecoin pegged to the US dollar, this problem could be solved, bringing more liquidity and efficiency to the digital currency market.

• In 2015, Tether officially launched USDT and started trading on several mainstream digital currency exchange platforms. At that time, USDT primarily utilized the Omni protocol on the Bitcoin network for transfers and verification. Each USDT was treated as a token on the Bitcoin network, leveraging its security and decentralized characteristics.

• In 2017, with the explosive growth of the digital currency market, USDT experienced significant demand and usage. Tether began expanding the issuance of USDT and released different versions of USDT on multiple blockchain networks, such as Ethereum, TRON, and EOS. The purpose was to enhance the usability and flexibility of USDT, allowing users to choose different networks for transfers and transactions.

• In 2018, Tether faced a series of doubts and controversies. Firstly, there were concerns about whether Tether actually had sufficient USD reserves to support the value of USDT since the company had never publicly disclosed its reserve proof or undergone third-party audits. Secondly, there were allegations of a close relationship between Tether and the Bitfinex exchange, with suspicions of market manipulation. Lastly, users grew concerned about the stability of USDT value after Tether modified its terms of service on its website, changing the commitment to peg USDT to the US dollar to a more ambiguous statement.

• In 2019, Tether faced an investigation and lawsuit from the New York Attorney General’s Office (NYAG). The NYAG accused Tether and Bitfinex of violating New York state law by concealing the fact that $850 million of funds were frozen or lost due to collaboration with a payment processor called Crypto Capital. It was alleged that $850 million worth of USDT under Tether’s control was used to cover Bitfinex’s funding gap. This incident raised doubts in the market about whether USDT truly had sufficient USD reserves, resulting in some price fluctuations.

• In 2020, while dealing with the legal proceedings, Tether continued to expand the issuance and coverage of USDT. Tether released USDT on various emerging blockchain networks, such as Algorand, Solana, and Tron. It also collaborated with multiple digital currency service providers and institutions to promote the usage scenarios and value of USDT. Tether began issuing stablecoins pegged to other fiat currencies, such as the euro, Chinese yuan, Japanese yen, to meet the demands of different regions and markets.

• In 2021, Tether reached a settlement agreement with the NYAG, ending the more than two-year-long lawsuit. According to the agreement, Tether agreed to pay a $18.5 million fine to the NYAG and submit reserve reports and related documents to the NYAG on a quarterly basis. Tether also agreed to no longer provide services to users or institutions in the state of New York. Additionally, Tether started regularly disclosing the composition and proportion of its reserves and hired an audit firm named Moore Cayman to conduct audits of its reserves.

• In 2022, Tether maintained its leading position in the stablecoin market and continued to innovate and improve in various aspects. For example, Tether introduced a new version called Liquid USDT, which utilized the Liquid sidechain technology on the Bitcoin network to achieve faster and more private transfers. Tether also collaborated with several central bank digital currency (CBDC) projects, exploring how to utilize USDT to facilitate cross-border circulation and interoperability of CBDCs.

Technical Architecture and Operation Mechanism of USDT

USDT was initially issued on the Bitcoin blockchain using the Omni Layer protocol. The Omni Layer protocol is a second-layer protocol that enables smart contract functionality on the Bitcoin blockchain and allows for the creation of new tokens on the Bitcoin blockchain. Tether utilizes the Omni Layer protocol to convert fiat currencies such as the US dollar into digital currencies. For every USDT issued, Tether stores one US dollar in its bank account as a reserve. The issuance and circulation process of USDT can be divided into the following steps: – Users deposit US dollars into Tether’s bank account; – Tether creates individual Tether accounts for users and deposits the corresponding amount of digital currency into the accounts; – Users can trade USDT on exchanges or over-the-counter markets, or use USDT to purchase other cryptocurrencies; – Users can redeem an equivalent amount of US dollars in cash from Tether at any time, and Tether will destroy the corresponding amount of USDT. Tether claims that its fiat reserve accounts undergo regular audits to verify that they can effectively support the value of circulating USDT. Tether also claims that all its transactions are recorded on the public blockchain, and anyone can view its issuance and circulation volume. In addition to USDT based on the Omni Layer protocol, Tether has also issued USDT on other blockchains, including Ethereum, Tron, EOS, Algorand, etc. These USDT tokens on different blockchains are all pegged to the US dollar but use different technical standards and protocols.

As a stablecoin, USDT plays an important role in the cryptocurrency market, mainly in the following aspects:

• Hedging market risks. When the cryptocurrency market declines, investors can convert other cryptocurrencies into USDT to protect their assets from price fluctuations. When the market recovers, investors can convert USDT back into other cryptocurrencies to participate in trading.

• Providing trading intermediaries. Since many cryptocurrencies do not have direct channels for fiat currency conversion, investors need to use USDT as an intermediary to facilitate the conversion between fiat currency and other cryptocurrencies. This can save time and costs and avoid exchange rate risks.

• Supporting payment settlements. Due to the equivalent value of USDT to the US dollar and the use of blockchain technology for fast, low-cost, secure, and transparent value transfers, USDT can be used in scenarios such as cross-border remittances and payment settlements.

Challenges Faced by USDT

Despite the widespread application and influence of USDT in the cryptocurrency market, there are also challenges and risks, mainly in the following aspects:

Firstly, the issuer of USDT is Tether, a company that has not openly and transparently disclosed the reserves backing USDT. In other words, we do not know if they actually have enough US dollars to support the value of USDT. If they don’t, USDT may face a credit crisis, leading to a decrease in user trust and even triggering panic selling. This situation has occurred several times before, such as in October 2018 when the price of USDT briefly fell below $1, causing market volatility.

Secondly, USDT has also faced some legal and regulatory pressures. Previously, Tether and the Bitcoin trading platform Bitfinex were sued by the New York Attorney General, accusing them of covering up a $850 million fund gap in 2018 and misleading investors. Although the two parties eventually reached a settlement agreement of $185 million, this also had a negative impact on USDT. In addition, some countries and regions have also imposed restrictions or bans on stablecoins, such as China and India.

Lastly, USDT also faces challenges from competitors. With the development and innovation of blockchain technology, more and more stablecoins are appearing in the market, such as USDC, DAI, BUSD, etc. These stablecoins have their own advantages and characteristics, such as higher security, better compliance, more application scenarios, etc. They may attract some of USDT’s users, thereby affecting USDT’s market share and position.

USDT in China is awkward

According to the latest policy in China, virtual currencies do not have the same legal status as fiat currencies, which means they cannot be used as tools for payment and settlement. The related business activities of virtual currencies are considered illegal financial activities, including issuance, trading, agency, custody, etc. Any organization or individual investing in virtual currencies and related derivatives, if it violates public order and good customs, the relevant civil legal actions are invalid.

This means that if you buy or sell USDT, you may face the following risks:

• The counterparty may be a criminal, using USDT for illegal activities such as gambling and smuggling. Once discovered and marked as a blacklisted entity by judicial authorities, you may be suspected of money laundering or other crimes.

• The trading platform may be illegal, with risks of running away, being seized, or being hacked, resulting in the inability to withdraw or loss of your funds.

• It may be difficult to protect your rights in case of trading disputes because buying and selling virtual currencies are considered invalid civil actions and are not protected by law. If the counterparty breaches the contract or commits fraud, you may not be able to recover your losses through normal channels.

So, how to reduce the legal risks of USDT? As lawyers, our advice is: try to avoid buying and selling USDT and try to avoid allocating too much USDT as your digital assets.

If you insist on buying or selling USDT, then you should at least do the following:

• Choose a legitimate and reputable trading platform, stay away from unreliable platforms.

• Check the counterparty’s identity information and reputation, avoid trading with suspicious or dishonest individuals.

• Keep the transaction vouchers and evidence, including transfer records, chat records, contract agreements, etc.

• Comply with relevant national laws and regulations, do not participate in any illegal activities or speculative trading.

Summary

• USDT is a stablecoin issued by Tether that is pegged to the US dollar. It plays an important role in the cryptocurrency market, providing users with a stable value anchor and medium of exchange.

• USDT has been issued since 2015 and has gone through multiple changes and challenges. It is currently one of the largest and most widely used stablecoins. USDT has different versions on different blockchain networks and collaborates with multiple cryptocurrency service providers and institutions to expand its use cases and value. However, USDT also faces some doubts and controversies, primarily concerning its reserve proof, legal compliance, and market influence.

• As a virtual currency, USDT faces strict regulation and restrictions in China. As users, we should rationally evaluate the value and risks of USDT and not blindly follow trends or take risks by hoarding it.

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