Analyzing losses for Tether holders in events unpegging from dollar

Tether (USDT) is a popular stablecoin that aims to maintain a 1:1 peg to the U.S. dollar. However, there have been periods where Tether has lost its peg and traded below $1. These temporary breakdowns in the peg have resulted in losses for some Tether holders. In this article, we will analyze the potential losses that Tether holders can face when events cause Tether to unpeg from the dollar.

What causes Tether to lose its peg?

Several factors can cause Tether to lose its peg to the dollar:

  • Lack of confidence in Tether's reserves - If there are concerns that Tether does not have sufficient dollar reserves to back all Tethers in circulation, it can lead to selling pressure. This decreases the price below $1.
  • Redemption requests - If many Tether holders try to redeem their USDT for dollars at once, it can strain Tether's reserves and cause the price to drop below $1.
  • Crypto market volatility - In times of extreme volatility in the overall crypto market, stablecoins like Tether can lose their peg as traders sell stablecoins to get into dollar positions.

How low can Tether unpeg during severe breakdowns?

In previous incidents of Tether sharply losing its dollar peg, USDT has traded as low as $0.925. This represents a 7.5% drop from the intended $1 valuation.

The lowest Tether has historically dropped is:

  • October 2018: Fell to $0.925 amid lack of confidence in reserves.
  • March 2020: Dropped to $0.967 during liquidity strain in crypto markets.

However, it's possible an even more severe breakdown in Tether's peg could occur in hypothetical scenarios like a "run on the bank" if redemption requests spike. In a worst case, Tether could potentially trade at a much larger discount until peg is restored.

What are the implications for Tether holders?

When Tether unpegs and drops below $1, there are several implications for holders:

  • Temporary loss of pegged value - Holders will see the dollar value of their Tether drop during the period of the peg breaking. This can result in meaningful financial losses if the unpegging is significant.
  • Loss of redeemability - One of Tether's promises is that holders can redeem 1 USDT for $1. However, during events where the peg is lost, Tether often suspends redemptions, depriving holders of the ability to exchange USDT for fiat.
  • Decreased utility - Since Tether is no longer maintaining its value at $1, it loses usefulness as a stable store of value or unit of account during the period of the unpegging. Holders lose a key benefit of Tether.
  • Knock-on effects - Tether losing its peg can have ripple effects into the broader crypto ecosystem in terms of market confidence and liquidity flows between assets. This can amplify losses.

What can holders do to protect capital during an unpegging event?

Here are some steps Tether holders can take to try and minimize capital losses if Tether loses its dollar peg:

  • Temporarily move to other stablecoins - Convert USDT to stablecoins like USDC that are still functioning as intended to avoid further losses.
  • Get into dollar positions - Buy assets pegged to dollars, such as fiat-collateralized stablecoins, to preserve USD value.
  • Wait for peg restoration - If comfortable with the counterparty risk, simply wait until Tether restores the proper peg before making further moves.
  • Temporary redemption suspension - If redemptions are still open try redeeming Tether for dollars before the option is suspended.
  • Use Tether temporarily for payments - To the extent possible, use unpegged USDT to make payments and purchases to avoid having to sell at a discounted rate.

The key is taking action before the unpegging deepens and causes excessive capital depletion. Quickly getting into stable dollar positions can minimize the fallout.

"As a long-time Tether holder, I've learned to keep a close eye on the peg to try and get ahead of potential breakdowns. It's frustrating but necessary in order to protect my investments."

Tether aims to be a stable asset but has proven itself to occasionally break down and unpeg from the dollar during market stress events. As demonstrated above, these breakdowns can have meaningful implications for holders in terms of temporary loss of value, liquidity, and utility. By monitoring for signs of peg weakness and having a plan to shift into more stable holdings, Tether holders can work to insulate their portfolios from the worst effects of an unpegging. Remaining vigilant is key to navigating these turbulent scenarios.

How likely is a severe and prolonged breakdown in Tether’s dollar peg?

While minor temporary losses of Tether's peg to the dollar have happened on several occasions, a major and extended breakdown is probably unlikely in the current market environment due to:

  • Ongoing redemption availability - Tether has maintained ongoing redemptions, allowing holders to cash out USDT for fiat and preventing a spiraling unpegging.
  • Reserves transparency - Tether has taken steps to provide more transparency into its reserve holdings, easing concerns.
  • Market experience - Exchanges and traders have gained experience in previous temporary unpeggings, and likely would step in with arbitrage to restore peg rapidly.
  • Competition - Alternate stablecoins provide other options for traders to move funds, lessening risk of severe Tether unpeg.

However, in a hypothetical crisis scenario such as mass redemption demands that depleted reserves, a prolonged breakdown in Tether’s 1:1 dollar peg could potentially occur, leading to much more extensive losses until stability was restored.

What emergency measures could Tether take to quickly restore a dollar peg?

If faced with a major unpegging crisis, Tether could take emergency steps to try to restore the critical 1:1 dollar peg and stabilize its stablecoin. Some options include:

  • Halt redemptions - Temporarily suspend all USDT for fiat redemption requests to stem sell-side pressures.
  • Asset sales - Liquidate reserves holdings such as BTC into dollars to generate liquidity and fund redemptions.
  • Borrow capital - Leverage Tether’s remaining reserves to quickly borrow cash through venues like interbank lending.
  • Burn USDT supply - Destroy outstanding Tethers to reduce circulating supply and prop up the price.
  • Increase transparency - Provide detailed real-time reserve accounting to prove dollar holdings and restore confidence.
  • Exchange incentives - Offer lucrative compensation for exchanges to prioritize Tether-dollar trades and arbitrage to stabilize the peg.
  • Code update - Modify smart contract code to enforce restored peg or implement temporary exchange rate adjustments.

Time is of the essence in acting to preserve the 1:1 peg and utilize all options available to avert a deeper crisis of confidence.

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