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> If Tether worked as it was advertised there would be no profit opportunity

Of cause there would. Even if the tokens are backed 1:1 by dollars it still has an exchange rate. So tether could issue at above 1 rates and buy at below 1 rates. That provides a very simple profit making scheme.

For users, they would often like to “cash out to tether” quickly, which means they’d undercut the exchange rate thus providing tether with a profit in exchange for swift processing.

> If we were in a fantasy land where Tether wasn’t fraudulent then the price variance of Tether on exchanges would be so minuscule that there would be no arbitrage opportunity for anyone to take advantage of.

I’m reminded of the joke where two wallstreet stock brokers are walking down the street, one says to the other “look a 50$ bill on the ground!” The other without looking down replies: “that’s impossible, if there was a 50$ bill on the ground someone would have picked it up.”

> Of cause there would. Even if the tokens are backed 1:1 by dollars it still has an exchange rate. So tether could issue at above 1 rates and buy at below 1 rates. That provides a very simple profit making scheme.

If USDT is credibly backed by dollars this spread is tiny, not least because other holders of Tether can play the same game. And if USDT is backed by dollars held in cash in customer accounts as originally claimed, there's an enormous opportunity cost of not investing those dollars.

Holders of Tether can play the same game, but they don't have the same advantage. Because of the knowledge imbalance, Tether has zero risk in this game. Any other player has the risk that they might lose money on a trade for whatever reason.

I agree the spread might be tiny though. Though if Tether puts itself in a bad light every now and again it could force the spread a bit wider.

You can invest the money, the same as banks do. It's why they don't charge you to store money with them, especially if your balance is high.

You only need and should keep enough liquid cash needed to handle day to day withdrawals. Everything else is fair game up invest.

See: https://en.m.wikipedia.org/wiki/Fractional-reserve_banking

https://en.m.wikipedia.org/wiki/Bank_run

I’m talking about the specific promises made by Tether. The question is not about whether or not fractional reserve banking exists, the question is how can Tether engage in fractional reserve banking (or any profit making activity) without being fraudulent when they explicitly claimed to hold 100% of their USD in cash reserves at all times?

“[...] each tetherUSD in circulation represents one US dollar held in our reserves (i.e. a onetoone ratio) which means the system is fully reserved when the sum of all tethers in existence (at any point in time) is exactly equal to the balance of USD held in our reserve.”

For the record, I think all this crypto currency stuff is plain dumb, and that tether is likely a fraud.

That said they don't state anything about what their reserve is. Wealthfront has a 2.3% savings account for us normal people. If I created a stable coin like tether is and had a billion dollars of investment; I could make 23 million dollars a year and tell people that I have a 1:1 backing without lying.

If I went to a bank with a billion dollars I could likely negotiate an even higher rate for such a savings account.

> If I went to a bank with a billion dollars I could likely negotiate an even higher rate for such a savings account.

I don't think that's how it works. As others have mentioned, FDIC insurance only covers 250k per depositor per bank. Typically when entities have that amount of cash (think Apple, Google, etc.), they put them into US government bonds, which are effectively equivalent to deposit accounts.

Edit: this is an interesting point, though. Ignoring the insurance issue, what would a bank do if you asked to open a deposit account with a billion dollars (paying, say 2%/year)? My uninformed layman's speculation would be that they would reject you because they wouldn't know what to do with that much money: they have to somehow lend out enough of it to at least break even on the 20 million/year that they're paying you for interest, but at the same time they have to be able to give you back your 1 billion at any time you ask for it.

I think they would totally take it, with all sorts of special terms. Also, they don't need to have a requirement to say they will get you all that cash immediately to keep the tether promise.

Lastly, putting that money in bonds, index funds, and other such things scales well. The wealthfront example I used took on a billion in deposits in a short timeframe: https://www.cnbc.com/2019/04/23/wealthfronts-new-high-yield-...

To your first point, if you have another entity do that type of investments for you and present it as a bank account with a variable interest rate; then you can claim you have a 1:1 cash backing truthfully, even if the reality is different. If you just stored the money in a normal bank, the reality would stay the same.

It’s also a thousand million dollars. That’s between 500 and 1000 mortgages in SF or NY. Any direct lender would love that opportunity; they’ll charge 4-5% on a 30-yr fixed and give you half.

> Edit: this is an interesting point, though. Ignoring the insurance issue, what would a bank do if you asked to open a deposit account with a billion dollars (paying, say 2%/year)? My uninformed layman's speculation would be that they would reject you because they wouldn't know what to do with that much money: they have to somehow lend out enough of it to at least break even on the 20 million/year that they're paying you for interest, but at the same time they have to be able to give you back your 1 billion at any time you ask for it.

Large banks deal with deposits in total orders of magnitude greater than that (the top banks have over $1 trillion each in deposits.) $1bn in a single demand deposit account is stupid for the depositor, but it doesn't move the needle on a major banks total of deposit accounts, and they can deal with it just fine.

Its multiple billions of USD they had. The most shrewd investments would yield tens of millions per year.

$100M in deposits is $5M/yr in returns on float, just as your bank and insurance companies do with your deposits and premiums. It's technically not risk-free (FDIC notwithstanding) but that doesn't stop anyone.

I’m not clear how that applies to Tether:

“[...] each tetherUSD in circulation represents one US dollar held in our reserves (i.e. a onetoone ratio) which means the system is fully reserved when the sum of all tethers in existence (at any point in time) is exactly equal to the balance of USD held in our reserve.”

Where does the 5% come from?

I, too, am interested to learn more about this totally risk-free 5%.

5% isn't possible, but you can make over 2% on treasury bills currently. The risk of the US government defaulting on loans can be essentially ignored.

This might be a dumb question but can you sell a treasury bond to a 3rd party before the terms are over without losing too much money?

Yes, they are completely liquid.

You can sell them before maturity, but their value will depend on current interest rates, of course. If rates are up, you will have to discount the price.

This might not be exactly answering your question, but you can buy 4 week treasury bills. Even if you can't sell bonds, having money tied up for 4 weeks might not be a big problem.

Except in the crypto industry, where US bonds are likely to be seized, and therefore probably have an average payout rate below parity.

Do you have any information about US bonds being seized like this? I don't understand how it could happen.

Exactly. And even if the US government were to default on loans Theter would be the least of your concerns since the USD and consequently the global economy would be in a pretty bad shape.

It's the gamble that banks make. A bank holds your money and will give it to you at any time. To fund this, they make an assumption about how many of their customers will actually want their money at any one time, and they invest the rest.

If all their customers decide to withdraw their money, this is a "run on the bank" and generally dooms the bank.

Presumably Tether planned to do the same: a percentage of the money they held would be invested, based on the assumption that not everyone who held Tether would want USD at any one point in time.

Of course, this stretches the meaning of "reserve", and utterly fails if they mismanaged the investment bit and lost the money they invested

Who’s making 5% risk free?

Can you point me in their direction?

You take some risk while externalizing the risk of insolvency to your customers.

It’s what every insurance company and bank does.

Or if you don’t want to do that, put it in treasuries or something and take your 1,2,3% of whatever it may be.

Tether could have replicated either strategy, but seems to not have.

They could also have profited from those that lost their keys (it happens).

They would need access to a broker to invest in treasuries and pass KYC/AML. Which treasury broker would onboard them if they struggled to get a bank?

Even treasuries are not risk free, nor are they unbounded. Tether is trying to play in the big league, I'm not certain what the rules are, but I'm pretty sure making 1%-2% annually on the float is a pretty good deal, and that might even be a conservative estimate.

In addition you have to keep in mind that it is also about absolute numbers. No one invested these billions with them, no one is charging them some kind of relative rent. Every dollar is profit. If you could make 0.001% off storing 5 billion, that would still be an attractive business model.

> If Tether worked as it was advertised there would be no profit opportunity.

Everyone gave multiple good profit opportunity already, but what about having a transaction fees? They still have a cost related to operating this business, you put that cost toward a transaction fee and you put a small profit on top.

That's how credit card works, though their fees apply much more often than it would for a stablecoin, where most transations aren't from the coin to fiat money.

> you accepting $100 USD from your friend and giving them $100 of Monopoly money

That's pretty much the definition of a bank. Banks does it for free ALL the time and has actual physical locations on top of that and has to operate locally too.