Anyone in the cryptocurrency space with half a brain knew something was up the minute they refused an independent audit. It was only a matter of time before someone brought charges and/or Tether collapsed.
So there are many iterations of compounded phantom value folded into the market cap of BTC. If tether is found insolvent, essentially 80% of the value of BTC disappears overnight.
The entire value of the crypto market depends on people's belief that one tether is worth 1USD. Or so the theory goes.
But that's not the potential issue being described: Tether is supposed to be worth 1 dollar. A lot of big crypto markets run on tether. If it turns out that a lot of crypto was bought with synthetic dollars (tether) that turned out to be a lot less than a dollar, that would mean the price of many crypto projects got to where it is by imaginary money. In another word: overpriced.
What happens when that safety net vanishes as hoards of people are running off the cliff?
Edited to add:
This isn't really a theoretical issue, either. Risk is part of the price of a security. Something that has a high risk, may be valued less by investors. Often other investments will carry the same amount of reward but less risk.
And yet it still trades 1:1 to USD today, after the court filing was released.
So is there some magic force that keeps the fraud running, and prevents market participants from cashing out their Tether in the mother of all bank runs?
If you hold Tether why wouldn't you sell?
Or is there more to the story than just "Tether is an obvious fraud"?
What do you get out of participating in the market if you expect Tether to be fraudulent? You'd personally price it at zero, then, right? Can you profitably short it, or does everything just break down if you're right?
That is, if you hold USDT and want to sell it for cheap, who is going to buy it for cheap-but-nonzero?
The market price for one Tether is currently $0.9984 because traders are buying at that price.
So if anyone holds Tethers and believes there's greater than 1% probability that it goes to zero, the rational trade is to sell.
The fact that the price holds at parity tells me that Tether is not an obvious fraud.
When you have nothing to trade but trust and hope, people who take advantage of trust and hope are always massively rewarded.
Occasionally someone crosses the wrong people and jail time ensues, but if you're politically adept enough to avoid that - at least until you die and/or disappear - no career pays as well as financial fraud.
If traders begin to lose faith in Tether, wouldn't they sell Tether and buy BTC, ETH, XRP, BCH, LTC, EOS etc.?
So wouldn't that cause the USDT price to decline to $0.97, $0.95, $0.90, $0.75, etc.?
And at the same time the demand for BTC, ETH, XRP, BCH, LTC, EOS would cause their prices to rise, wouldn't it?
I suppose at some point, after the $3B of Tether is liquidated, people could lose confidence in the entire market, but until that happens wouldn't cryptocurrency prices increase rather than decrease?
These will be exacerbated by exchanges which have been run in bad faith and which do not have either the cryptocurrency or fiat reserves they claim (see Quadriga CX for a recent example).
Either way, it's going to be interesting to watch.
On exchanges of questionably integrity. And where it is impossible to reliably short the instrument.
I see this a lot, if you can't sell short then the price can't decline?
If I held Tether and thought it was worth less than $1.00, I would sell it.
If most people think it's worth less than $1.00, they would sell it and the price would drop to reflect the risk.
Why doesn't this happen? Is is just crooked exchanges posting phantom orders? If so, why don't smart traders sell into that and liquidate?
Also there is empirical proof short selling matters because during the banking crises they banned short selling which causes certain bank stocks to jump up, and then when they allowed it again the prices fell like a rock.
Alternatively, perhaps people expect the revelation that Tether isn't fully backed to proceed like the dollar going of the gold standard. It comes with a lot of noise, but the thing keeps working because people keep using it. In this scenario, Tether essentially becomes Bitfinex fiat. That would be a really cool dystopia.
Hence there might be tears