Tether (USDT) operates similarly to fractional reserve banking, but in the world of cryptocurrency. Instead of only issuing USDT in exchange for real USD deposits, Tether uses a recycling process with corporate debt (bonds) to multiply the money supply, creating more USDT than the initial deposit.

The Process: Turning $1,000 into $10,000 in USDT

Here’s how it works, spelled out over two rounds of USDT creation:

Round 1:

1. Initial Deposit: Let’s say MicroStrategy (MS) deposits $1,000 in cash into Tether. In return, MS receives 1,000 USDT from Tether.
2. MS Issues New Corporate Bonds: MicroStrategy creates new corporate bonds worth $1,000 — essentially printing new debt. Tether purchases these bonds from MS using the $1,000 in cash it initially received.
3. MS Exchanges the Cash for More USDT: Now, MicroStrategy takes the $1,000 in cash (received from the sale of the bonds) and exchanges it for another 1,000 USDT from Tether.

Round 2:

1. MS Issues More Bonds: MicroStrategy creates even more bonds, issuing another $1,000 worth of corporate debt.
2. Tether Buys the New Bonds: Tether purchases these newly created bonds from MicroStrategy using the $1,000 in cash it received in Step 3.
3. MS Exchanges the Cash for More USDT: Finally, MicroStrategy takes the $1,000 in cash (received from selling the bonds) and exchanges it for another 1,000 USDT from Tether.

The 10x Multiplier Effect

Because MS can create new bonds (debt) and Tether buys them in exchange for more USDT, the amount of USDT in circulation multiplies with each round. So, from the initial $1,000 in cash, the amount of USDT in circulation could eventually grow to $10,000 or more, as Tether continues to print new USDT based on each new issuance of bonds.

Why This Makes the Market Easily Manipulable

This process of inflating the money supply is why Tether is so influential and why the crypto market is easily manipulated. By increasing the amount of USDT in circulation, Tether can inject liquidity into the market, pushing cryptocurrency prices up. Conversely, by reducing the amount of USDT, it can remove liquidity, causing prices to fall. This manipulation of the money supply can create wild price swings, as traders and market makers adjust their strategies to the changing liquidity.

This is similar to how central banks use monetary policy to create inflation or deflation in the economy. However, because Tether operates with far less transparency and less regulation, it creates greater opportunities for manipulation in the crypto market.

Conclusion

In conclusion, Tether functions much like a fractional reserve bank, but instead of issuing USDT only for cash deposits, it uses a recycling process with newly created corporate bonds. This allows Tether to multiply the amount of USDT in circulation — creating a multiplier effect that increases the money supply. This process creates liquidity inflation in the crypto market, enabling price manipulation and volatility, and is a significant reason why the crypto market is so susceptible to manipulation.