Dovey Wan: The Development Logic and History of USDT

This article was published on May 7, 2020, on Dovey Wan's Weibo.

Stablecoins are a business of monetizing liquidity through credit, with the key concepts being credit and liquidity. Tether's dominance in the stablecoin market actually follows a similar intrinsic logic to the dollar's path to becoming the world's dominant currency (or the future internationalization of the renminbi). Reflecting on a long conversation I had with Brock Pierce (one of the founders of Tether), despite various controversies surrounding him, I still greatly admire his foresight and execution back then, as well as his courage to challenge the greatest interests of sovereign states. Here, I will make a parallel comparison between Tether and the dollar to share some of my thoughts and conclusions:
Tether 1.0:
Background: Brock mentioned a term, saying that Tether was not originally a business, but a pure utility, and a provider of a highly risky utility. He made an analogy that a group of farmers discovered that using electricity was better than burning coal; electricity was stable, but there were no power lines in their forest, so they secretly brought a power line from the city. The farmers had no guns, and stealing electricity could get them shot by soldiers from the city, but once they had electricity, the countryside began to develop rapidly and formed its own industrial system, which might eventually lead to a confrontation with the soldiers in the city (if the power supply was cut off during development, this fragile early industrial system would inevitably collapse).

1. Anchor known maximum credible asset: the dollar 'zero education cost and credit building cost'
2. Issuer as a credible entity at the time: Bitfinex 'a well-known exchange, the exchange is the largest credible third party in the world of cryptocurrency, with the second being mining pools, which are barely considered credible since computing power is hosted, but their scale is too small and frequency too low; I will write a post about mining pools later'
3. Issuer can directly provide cold-start liquidity: Bitfinex 'the high turnover attribute of exchanges determines the trading medium, which here is stablecoins, justifying their existence'
   Dollar 1.0:
   Background: After joining World War II later, the U.S. had no battles on its soil, and its productive and industrial capabilities provided a large supply for wartime trade, thus acquiring a massive amount of the world's gold reserves. The U.S. gold reserves increased from over 200 tons at the end of the 19th century to over 20,000 tons after World War II, a direct increase of 100 times. After World War II, the U.S. quickly held more than half of the world's gold reserves.
4. Anchor known super-sovereign value storage: gold 'zero education cost, and everyone knows the U.S. holds a large amount of gold reserves'
5. Issuer as the strongest country in post-war GDP and overall strength: the U.S. 'At the Bretton Woods conference, leaders from other countries chose to believe in its ability to redeem gold and maintain the dollar/gold peg'
6. Issuer can directly provide cold-start liquidity: the U.S. 'Because the U.S. has gold reserves, it can provide dollar/gold exchanges, and on the other hand, it has a large amount of trade goods needed by other countries, becoming a huge supplier for the post-war reconstruction of Europe, Japan, etc. There is a huge demand for dollars on the demand side.'
   Tether 2.0
7. Liquidity rapidly expanded, spilling over to various trading platforms: due to the strong network effects of liquidity itself, spillover was inevitable. In addition to exchanges, a large over-the-counter exchange network was established, and this network is relatively spontaneous and decentralized, which is very important; I will discuss this property in Tether's anti-fragility in 3.0.
8. Bitfinex was hacked, almost facing a crisis, and after debt/equity/token restructuring, it was resolved. This was Bitfinex's biggest credit crisis, which also affected Tether.
9. Tether's transparency and reserve ratio have been questioned multiple times, but so far there have only been three non-legally binding third-party audits and proofs, which can only prove that at "a certain time," Tether was 100% reserved. This led to a credit crisis for Tether among various parties in the cryptocurrency space.
10. Countries struck hard, discovering farmers stealing electricity, deciding to cut off the power? Among them, the most famous was in 2017 when the major U.S. bank Wells Fargo froze BFX accounts, and BFX and Tether took Wells to court. Then there was the investigation and lawsuit by the U.S. Federal Prosecutor's Office against Tether's parent company in 2018, as well as Noble Bank and other banks ending their business dealings with Tether. Here, it is not difficult to see that the power supply here is fiat onramp. The banking system is the most critical power line.
    Dollar 2.0
11. Dollar liquidity expanded, and the U.S. continued to export inflation abroad. The surplus of survival caused by globalization of capital and the huge expenses of the Vietnam War led to a skyrocketing U.S. government fiscal deficit.
12. The U.S. issued a large amount of dollars to fill the fiscal deficit from the Vietnam War, and European countries accumulated a large amount of dollars during their post-war recovery.
13. Europe anticipated that the U.S. would continue to issue a large amount of dollars, starting to sell off reserve dollars in exchange for gold. By 1968, the U.S. announced that it had only over 9,000 tons of gold left, down from over 21,000 tons in 1945.
14. The U.S. gold reserves were also opaque, and the significant reduction in domestic gold reserves further strengthened the market's expectation that the dollar would soon depreciate significantly and that gold prices would rise, leading European countries to further sell dollars to buy gold, resulting in a dollar credit crisis.
    This issue is called the Triffin dilemma, a problem mentioned by the famous economist Robert Triffin in his 1960 publication "Gold and the Dollar Crisis - The Future of Convertibility" (note that at this time, the Bretton Woods system had not yet completely collapsed). The dilemma is roughly as follows:
    After World War II, the U.S. exported dollars, for example, the "Marshall Plan" to help countries rebuild, which effectively solved the international "dollar shortage" problem and expanded countries' trust in the dollar, giving the dollar world-class gold credit (this is also why the dollar is called "greenback"). As the strongest military power, the U.S. maintained local reconstruction order through its military presence in various countries, which also served as another guarantee of credit.
    With the long-term export of dollars, dollars accumulated and were reserved outside the U.S. When the reserves reached a certain level, for example, in the late 1950s and early 1960s, due to the relative transparency of the dollar's flow and reserves outside the U.S. compared to its own gold reserves, dollar holders would discover, "Wow, how come all the dollars combined exceed the U.S. gold reserves?" So why can the dollar and gold still maintain a fixed exchange rate? Is the dollar still credible? Then countries began to sell dollars to buy gold, causing gold prices to rise. To maintain the dollar's price against gold, the U.S. had to sell its gold, leading to a significant loss of its gold reserves. In the end, to preserve its gold reserves, the U.S. had to announce the decoupling of the dollar from gold.
    This dilemma was gradually played out in the 1960s, culminating in Nixon's announcement of the "New Deal" in 1971, which included the decoupling of the dollar from gold and the cessation of obligations to exchange dollars for gold for foreign governments or central banks (what a bold move…). The Bretton Woods system thus collapsed.
    Tether 3.0
15. The two major U.S. regulatory bodies, the CFTC and the U.S. Department of Justice, began a series of investigations into Tether, BFX, and BFX-related banking relationships at the end of 2017. Although BFX and Tether are not U.S. companies, as long as they involve dollar transactions and U.S. customers, long-arm jurisdiction remains effective. This is a clash between the world's largest currency hegemony and the pirates of the cryptocurrency world.
    I have mentioned more than once in public that the BFX and Tether teams have a strong "pirate spirit." The pirate spirit in the crypto circle is a neutral term; one can imagine the movie "Pirates of the Caribbean," where the pirate spirit exists in a chaotic, rule-less environment, having its own moral views and rules of conduct. It can be good, it can be evil, or it can be neutral.
16. Each time negative regulatory news emerged, it did not significantly impact Tether, but rather, during several instances of negative news about banking relationships, Tether's stability was suddenly breached, with the most recent instance occurring in October 2018, when it briefly dropped to $0.80.
17. Tether's credit crisis is 'not about regulation'; non-compliant Tether can coexist long-term with compliant stablecoins like TUSD, USDC, etc. Tether's credit crisis always stems from the 'redemption crisis,' which is similar to the runs that occur in existing banks during crises due to insufficient reserves (U.S. banks are required to maintain a 10% reserve, and after the 2008 financial crisis, they were required to have excess reserves—more than the 10% reserve kept at the Federal Reserve, which pays a certain interest).
18. In April 2019, Tether admitted that USDT is not 100% backed by dollars, but rather about 70% in dollar reserves, with the other 30% in other forms of assets, such as bonds and equities. However, after Tether's admission, the stability of USDT was not significantly affected, and its issuance continued to rise.
19. As mentioned earlier, after Tether's liquidity expanded, a large-scale over-the-counter exchange network was formed, which is actually an important guarantee of Tether's stability. For any node using or exchanging USDT, they do not care whether Tether itself can ultimately have 100% dollar redemption capability; they only care whether their upstream and downstream partners are willing to accept USDT at a price around $1. The larger the liquidity of USDT, the stronger its ability to peg to the dollar, and the more stable its price will become. This decentralized redemption network, as liquidity expands and use cases diversify (for example, foreign trade, buying masks), will become increasingly robust, enhancing Tether's anti-fragility significantly. Therefore, whether it is regulation or non-100% reserves, these credit crises are weakened in the face of strong liquidity.
20. In 2019, Bitfinex completed a so-called $1 billion IEO, but I personally believe that the actual amount received was perhaps only tens of millions of dollars, to alleviate its liquidity crisis caused by the freezing of dollar accounts by the U.S. Federal Prosecutor's Office. The IEO received support from many hardcore players in the circle, Bitcoin veterans, and even competitors like BitMex founder Arthur Hayes. Arthur once said something I agree with: Tether has essentially become the Federal Reserve of our industry; the Fed cannot fail because Tether is no longer just Bitfinex's Tether.
    Dollar 3.0
21. After the collapse of the Bretton Woods system, in the same year Nixon announced the decoupling of the dollar from gold, to ensure the dollar's position in international trade, the U.S. targeted the world's most liquid and largest commodity—oil. Nixon provided military support and protection to Saudi Arabia, the largest oil-producing country in OPEC and the world's largest oil exporter, in exchange for the condition that all Saudi oil exports must be settled in dollars. In October 1973, OPEC accepted the dollar settlement condition, establishing the petrodollar system. At this point, the dollar should have been renamed "oil dollar." [smirk]
22. The direct result of the petrodollar was that many Middle Eastern oil-exporting countries accumulated a large amount of dollars, and due to the transfer of U.S. production, countries like China, Japan, and South Korea also accumulated a large amount of dollars from trade surpluses. With all countries holding large amounts of dollars, purchasing U.S. Treasury bonds to lend dollars back to the U.S. became a natural choice. Thus, we see the U.S. continuing to export its own inflation, with domestic prosperity, stable prices, and a thriving economy, while regional crises abroad continue, with constant wars; any country that threatens the core position of the dollar (like Saddam or Karzai) is met with military force.
23. In almost every regional crisis, such as the Asian financial crisis or the Latin American financial crisis, we see the heavy shadow of "dollar liquidity crisis" after the crisis. Although it is unclear whether the U.S. government intentionally benefits from these crises, it is undeniable that the U.S. controls the liquidity of the dollar, which can save lives or kill.
24. This oil crisis and the trade war ultimately boil down to a currency war between major sovereign states. Before taking action, Russia had already cleared out all dollar assets from its foreign exchange reserves. The U.S. will go to any lengths to ensure the dollar's position because weaponized dollars can easily kill invisibly, easily declaring a country's economic death on the international stage. Therefore, I previously mentioned on Weibo that
    "This oil crisis may become the starting point for the dollar's crisis as an international settlement currency. In this context, combined with the pandemic, it provides a huge boost for the internationalization of the renminbi. After the collapse of the Bretton Woods system, the U.S. transformed 'gold dollars' into 'petrodollars' to maintain its international settlement position and its alliance with Saudi Arabia, the world's largest oil exporter. The political rift between Saudi Arabia and the U.S. will further break this 50-year-old interest alliance. On the other hand, Russia's foreign exchange reserves have basically no dollar assets left, and China, as the largest importer of oil, uses renminbi for oil trade settlements. If the dollar's liquidity and demand are significantly compressed in front of the world's largest commodity, combined with the trend of de-globalization, the days of relying on the petrodollar to fleece the world may not be long."
    At this point, I hope everyone can understand how credit currencies operate through the example of Tether and the comparison with the dollar. Additionally, what elements are needed to launch and maintain a stablecoin project: 1. Credit endorsement (government, large enterprises, major financial institutions, exchanges, high-end face recognition, etc.) 2. Liquidity support (large trading institutions, exchanges, etc.) 3. Liquidity channels and underwriting networks (government, major financial institutions, large marketplaces, large trading institutions, exchanges, various magical use cases, etc.). If these three major elements can be gathered, along with favorable timing, location, and boldness, creating a stablecoin project is akin to becoming a private central bank, making various operations like tax collection and fleece easy. As for how stablecoin projects make money, the reasoning is similar to that of central banks. Legitimate ways to make money can include: bidirectional redemption fees, issuance fees. Less honorable ways to profit can include: inflating and deflating, after all, it's their own printing press, dark trading, harvesting retail investors, etc.
    However, for Tether, the opportunities for wrongdoing are simply too many and too great, with chances to run away occurring no less than ten times. Since they chose to stay and continue to confront the iron fist, this behavior of "choosing a more perilous path" and opting to repay after being hacked and indebted is, in fact, the greatest credit in this circle.
    Any centralized single point of failure needs to be vigilant, and Tether is no exception. The continuous growth of Tether's scale will inevitably become a single point of failure in the industry, similar to exchanges. Therefore, I welcome the emergence of various competitors to Tether. However, as long as there are still reserves backed by dollar redemption, the Federal Reserve will always be the one who laughs last. All designs and efforts merely continue to help the dollar hegemony dress up, regardless of whether you are an Omni chain asset, an ERC20, TUSD, or USDT, the ghost of the dollar will always be present.