How Tether Makes Money Through Fees and Interest from Lending Reserves

Tether has become one of the most widely used stablecoins in the cryptocurrency market. As a stablecoin, Tether aims to maintain a value pegged to fiat currency, usually the U.S. dollar. This allows cryptocurrency users to have a stable asset amidst the volatility of the crypto market.

Tether generates revenue in a few key ways: transaction fees, interest from lending reserves, and investing reserves. Let's take a closer look at how Tether profits from fees and lending interest specifically.

Transaction Fees

One way Tether generates revenue is by charging fees for transactions done on the Tether network. These are usually very low fees, often under 1%. But with the high volume of Tether transactions, those tiny fees can add up.

For example, if there are $50 billion worth of Tether transactions in a day, and Tether charges a 0.1% fee, that would generate $50 million in revenue just from transaction fees. As one of the most widely used stablecoins, Tether processes billions in transaction volume daily.

Tether transaction fees apply whenever Tether tokens are sent from one Tether-compatible wallet or exchange to another. The fees act as an incentive and reward for the entities processing and validating transactions on the network.

Interest from Lending Reserves

Tether also generates income by lending out the reserves that back its stablecoin.

Tether's reserves are held in cash and cash equivalents, like commercial paper, bonds, and precious metals. Tether lends these reserves to institutional investors and charges interest on the loans. The interest earned provides significant revenue.

“We make a lot of money through our reserve lending,” Tether's general counsel Stuart Hoegner said in an interview. “Our overnight lending rate is about 7%; our term lending rates are about 12%.”

With tens of billions in reserves, earning even single digit interest rates results in massive interest income. Tether pools the interest earned on reserves and uses it to pay operating costs, invest in growth, and buy back tether tokens.

As crypto investor Cory Klippsten noted, “Tether's $60 billion treasury probably yielded $600 million a year in interest when it was conservatively invested in safe assets like cash and Treasurys."

This interest income is likely over a billion dollars a year with riskier but higher-yielding investments.

Investing Reserves

A third way Tether profits is by investing its reserves into other assets beyond cash and cash equivalents. These include things like bitcoin, equities, real estate, and private equity investments.

Tether CTO Paolo Ardoino has acknowledged that a portion of reserves are allocated to bitcoin to diversify away from just holding dollars. While riskier, bitcoin and other investments can provide higher returns than conservative reserve lending.

As one industry observer put it, “Tether is essentially a massive crypto hedge fund.” Between interest income and investment returns, Tether's reserves generate robust profits.

Controversy Around Reserves

However, Tether's reserve composition and risk management has also attracted controversy. There have been allegations that Tether does not fully back the tether token 1-to-1 with reserves.

Tether settled with the NY Attorney General in 2021 and paid an $18.5 million fine after admitting to only being 74% backed at one point. Tether maintains that it now has sufficient reserves, but has not provided conclusive audits.

Critics argue that Tether invests reserve assets in too risky of assets. But Tether counters that more conservative investments would not earn enough to sustain the Tether network. This debate continues as Tether works to provide transparency around its reserves.

Tether's Growth and Profitability

Despite controversies, Tether has rapidly grown into a highly profitable company. As J.P. Morgan analysts said:

"Tether surpassed a market cap of $60 billion at the beginning of March 2022. If we assume that Tether generates 25bp of fees per year on its circulating supply and lends out 80% of its reserves at 8%, it could already be generating over $1 billion in profits per year.”

As the adoption of stablecoins accelerates, Tether is positioned to continue reaping lucrative fees and interest income from reserves. Even with market volatility and regulatory uncertainty, Tether remains a dominant force in the crypto economy.

Should Tether Provide More Transparency Around Reserves?

Tether operates in a legal gray zone currently. Some believe Tether should provide detailed audits and transparency around its reserves and activities. But others think Tether does not owe the public full transparency like a publicly traded company.

More transparency could help restore trust and calm controversy around Tether's practices. But Tether also has understandable incentives to maintain some secrecy - disclosing reserve details could aid its competitors and attract regulatory scrutiny.

There are reasonable arguments on both sides of this issue. Ultimately though, Tether's growth and network effects show that most users still trust its stablecoin despite lingering questions. But if controversies escalate, calls for transparency may override Tether's reluctance.

Can Tether Maintain Its Dominance As Competition Grows?

Tether was the first major stablecoin and long dominated the market. But its share of the stablecoin market cap has declined below 50% recently. Rival stablecoins like USDC, BUSD, and DAI are rapidly gaining ground.

Can Tether maintain its commanding position amidst growing competition from other well-capitalized players? Much may depend on Tether's ability to innovate its product offerings and keep transaction fees competitive. But network effects are strong - for now, Tether remains the most widely integrated and adopted stablecoin.

Tether's first-mover advantage has allowed it reap immense profits so far. But in the fast evolving crypto industry, past performance does not guarantee future success. Tether faces risks from regulatory crackdowns and rivals eating into its market share over time. Its long-term dominance is far from guaranteed. But in the near-term, Tether still rules the stablecoin world and generates robust income from its operations.