Like much of the rest of the crypto world, we looked on as the bitcoin market spiked out of control in the early hours of Monday morning and Tether dramatically lost its dollar peg, at one stage touching $0.90.
What happened here? We may never know for sure, but with hindsight and a few extra clues we can piece together a likely scenario.
The Ultimate Fear Scenario was that Tether was insolvent – that it didn’t have the reserves to back USDT – and that traders in the know were cashing out. The only way to do that on Bitfinex was to buy BTC, leading to a premium of up to $1,000 on the exchange, albeit a short-lived one. Just like happened on Gox in 2013-14, there wasn’t any way to get fiat out, so the only way to rescue funds was to convert them to bitcoin and withdraw that.
If Tether really had been imploding, we would have expected matters to continue. The pump took place in the middle of the night for US traders, who make up a large proportion of the market. When they woke up, the action was over and prices were stabilising, having retraced around $1,000 on Finex. What US traders didn’t do was panic and dump their USDT. In fact, the whole thing was all but over in a couple of hours.
Much has been made of Bitfinex (temporarily?) losing its banking partner. So there’s no way of Tether moving money between tokens and dollars. Retail traders can’t cash out to their bank accounts anyway, but we’re assuming here that insiders – either big traders or possibly just Tether itself – can use that fiat gateway under normal circumstances. That’s how Tether keeps its peg usually. Someone can always buy USDT at sub-$1 levels, because they know they can exchange them for $1 each. It’s arbitrage, by any other name. Without that secret second market for Tethers, it’s just another alt, with fixed supply, and totally subject to the normal laws of supply and demand.
So what happened on Monday could have been this: With no bank, that secret USDT-dollar market was closed. There’s no way to arbitrage or move money around to buy underpriced Tethers. It’s an illiquid market, after days of inactivity, in the early hours of the morning, with bearish sentiment and LOTS of shorts on Finex.
It’s the perfect storm: the perfect time for a whale to smash the market by dumping Tether, buying bitcoin, pumping the price, wrecking all those shorts, as bots programmed to trigger at given points start buying and few traders are awake to sell. Prices can’t do anything other than rocket upwards. It was just possibly a freak coincidence of circumstances, but far more likely carefully planned and very, very well executed.
What would happen if USDT did fail?
If Tether ever does fail, if all those USDT are really worthless, here’s what’s going to happen. BTC will spike, hard, against USDT as $2.5 billion of fake money is dumped into the market. They’re going to get dumped, rapidly and relentlessly, by any and every trader who holds them, because if you wait for even seconds you’re going to get a worse deal. You’re going to sell Tether, buy bitcoin, and salvage whatever value you can. And that’s not going to stop until the Tethers run out or the exchanges halt Tether trading. It’s going to push BTC and any other coin that trades against USDT into the stratosphere, until those traders can figure out how to sell their crypto on other exchanges, which could be anything from hours to weeks (remember, they’re using Tether largely because they don’t want the inconvenience and oversight of registering and going through KYC). It’s going to drag the price up on other exchanges like Bitstamp, where they trade bitcoin against real fiat, though not as much as on the places where Tethers are being dumped like they’re radioactive. In short, you’re going to see a flight to safety – to crypto – like nothing the crypto world believed possible. When that kind of fear takes hold, it could be the largest and fastest spike upwards in value bitcoin has ever seen. And then the hangover will be utterly, utterly brutal.
But this time, it was just a temporary aberration. If it hadn’t been, you’d know about it – bitcoin would have soared through $10k and possibly even its ATH. And Tether would be priced in single figures, not just a couple of cents off the dollar.
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