The money that’s backing the Tethers. As an example - you deposit 1mm USD with Bitfinex, and they give you 1mm Tethers. Bitfinex invests your 1mm USD every night at overnight Libor, earning interest each day they do so. When someone (you?) wants to redeem the 1mm Tethers, Bitfinex gives them the 1mm USD, but keeps the interest it earned. You question is a good one, though - why would people ever pledge USD to create Tethers in the first place, given that treasuries have a higher (non-zero!) return? One example: if your 1mm USD came from a criminal enterprise, then you couldn’t deposit it at a brokerage and buy treasuries (due to KYC rules, etc).
I believe that's their business model. When there's a market pullback and many want to go into USDT, they sell their USDT for $1.04 or so, and when there's a bull-run and people want out at USDT, they buy back around $0.96.
Vitalik Buterin, the founder of Ethereum, published a post on coins like Tether a few years ago:
My understanding is that unless there's a "tether-run", where everyone wants to get out of Tether at once and the company behind Tether isn't well prepared for it, then that's when the coin may actually crash. Otherwise, it will self-stabilize by putting more Tether on the market, or taking Tether out of the market. So in a way, I guess it works a little like the Federal Reserve.
As for not having enough money to "back Tether", this is bad in the sense that they promised they would, and they're not showing proof that this is true. However, it's "only" as bad as any real-world bank that uses a fractional reserve banking scheme. So just like a fractional reserve banking entity would crash as soon as there is a major bank run, similarly Tether would crash if they don't actually have 1:1 USD:USDT backing.
So Tether is about as "shady" as any of the major US banks - and yes, I would agree that both are pretty damn shady. But this seems to be the status quo right now, so if you don't trust Tether, I surely hope you're not keeping your money in a bank either, because I think we're getting close to another financial bust, and we'll go through the same crap or worse that we went through in 2008 with the defrauding banks.
The second part of your post is utter nonsense. If a company makes money from issuing tokens and lying about them being backed by the USD, it's definitely more shady than a regulated financial institution which makes money by lending money at a higher rate than it borrows it, and is definitely more at risk of a "run" even without ignoring all the rules in place to ensure that banks will always be able to borrow at less than they lend, and protections for deposit holders in the event of a bank's loan portfolio going under.
In a normal bank run, the problem is that the people want the money back now but the bank has lend most of it and the money is locked in a 20 years mortgage. In some sense all the deposits of the bank are 100% backed. They just can't go immediately and reposes a house and send a bunch of brick to the people that want their deposits.
There are also some cases when the bank has no enough money (bad lenders selection, promised a too high interest rate, fraud, ...). In this case the deposits are not fully backed. But this is not the normal state of a bank.
Lots of downvotes, and a couple of replies from people who don't understand what fractional reserve banking is, and that the institutions lend (and trade, which was then more heavily regulated following the last crash, and is in the process of being deregulated again) on many multiples of what they actually have in deposits.
That said, they never claim to be 1:1. They claim to be operating within the legalities requires for fractional reserve banking.
People know exactly what fractional reserve banking is, and understand that it is ignorant at best to assert that banks creating credit and informed parties accepting that credit at parity with Fed-issued reserve notes because both parties understand how the system works and can access those reserve notes on demand where required and a criminal enterprise selling a claim on a nonexistent asset to people that believe their fraudulent representations are the same thing.
Banks profit from the repayment of loans, not directly from the issue of money, and banks' willingness to accept each others' credit at parity to m0 reflects their knowledge of the facts about other banks' expected future income streams and guaranteed access to an m0 lending facility, not ignorance of their counterparty not having what they claim to have. If everyone wants to withdraw their USD from a bank as cash, the reserve lending system is designed to actually allow this to happen. Banks fail, infrequently, because the number of people who fail to meet repayment obligations to the bank exceeds expectations, not simply and inevitably because not enough Peters are willing to be robbed to repay Paul.
The two are similar only in the same sense that a futures contract and a shyster selling you the Brooklyn Bridge both involve the other party selling something they might not be able to deliver.
> institutions lend .. on many multiples of what they actually have in deposits.
That is not true at all. You are probably thinking of the minimum capital requirements (banks leverage) which measures all lending (bank assets) against their common equity. Deposits and credits are roughly equal and the minimum capital is required to cover mispricing on their assets. And no, banks are not being deregulated in this regard. In fact Basel III which regulates those reserve ratios is much stricter and it took several years for banks to recapitalize to the new minimum levels.
Or you are thinking about the bank's deposit with the fed (the fractional reserve part). But those reserves are not a problem for banks because if there is lack of reserves on the interbank market and the price (interest rate) of borrowing reserve increases above the fed's funds rate, then the Fed steps in and provides the reserves at the rate it wants to keep. This is part of central banking because a central bank cannot simultaneously control the amount of reserves AND the interest rate.
Assuming it’s not an outright scam, what’s the business model for issuing and redeeming warrants at 1:1 parity?