Is Bitcoin Really Unrestricted? On the Impact of Tether on Bitcoin Prices

Source: Renmin University of China Financial Technology Research Institute

By John M. GRIFFIN and Amin Shams

Compiled by: Zhang Yueyang

Cryptocurrency has received much attention from the financial community due to its anonymous and secure features. The article “Is Bitcoin Really Untethered?” studies whether Tether, a digital currency pegged to the U.S. dollar, will affect the price of cryptocurrencies such as Bitcoin. The Institute of Financial Technology of Renmin University of China (WeChat ID: ruc_fintech) compiled the core content of the article.

The birth of cryptocurrency

Cryptocurrency has grown rapidly from scratch, with a market value of over $300 billion in just a few years, a development that is very similar to a "bubble" that relies on new technology. Cryptocurrencies such as Bitcoin provide an anonymous, decentralized financial system that is no longer subject to interference from banks and governments. The concept of Bitcoin coincided with the global financial crisis that broke out in 2008, which caused the public to have extreme distrust of banks and governments.

The issue that the article focuses on

Historically, rapid price appreciation has been associated with innovation and growth, but also with activity that leads to misallocation of capital. The semi-transparent nature of blockchains provides a unique opportunity to study the mechanisms behind the growth of asset classes during periods of massive speculation, helping to understand the role played by central monetary entities in the cryptocurrency world.

Tether (also known as Tether, USDT) is pegged to the US dollar and allows transactions without a bank intermediary, a feature that most cryptocurrencies do not have. In order to understand the reasons behind the boom in the cryptocurrency market in 2017, the authors give two alternative hypotheses: whether Tether's price fluctuations are demand-driven or supply-driven. Under the demand-driven hypothesis, investors use Tether as an exchange intermediary in order to get their assets into the "crypto space." Tether's price impact reflects natural market demand. Under the supply-driven hypothesis, the additional supply of Tether will lead to an inflation of the Bitcoin price.

Argumentation process

By comparing the Bitcoin and Tether blockchains, we can determine that when the Bitcoin price falls, an investor on Bitfinex uses Tether to buy a large amount of Bitcoin. Using an algorithm to analyze blockchain data, the authors found that during the market downturn, Tether prices doubled, which also led to huge increases in Bitcoin prices. This movement led to an asymmetric correlation within Bitcoin, indicating a lack of Tether reserves at the end of the month. Unlike demand from cash investors, these patterns are most consistent with the supply-based hypothesis that unsecured digital currencies drive up cryptocurrency prices.

in conclusion

Our findings support the view that price manipulation can have significant distortionary effects on cryptocurrencies. Market prices reflect much more than standard supply and demand and fundamental news. These distortionary effects, if unwound, could have a sizable negative impact on cryptocurrency prices. Innovative technologies designed to bypass the traditional banking system do not justify the elimination of external oversight, monitoring, and regulatory frameworks. Our findings suggest that suspicious activity is associated with bubbles and could lead to further price distortions.

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