The core of my question comes down to wondering what happens in the following scenario:
Consider a situation where it turns out that USDT (Tether) is actually not backed by any assets, which would mean that its value essentially goes from \$1 to \$0. What is the impact on people with investments in cryptocurrencies, and on the value of cryptocurrency itself?
Let's assume that by "cryptocurrency" I just mean "Bitcoin" to simplify things.
I guess that there are three ways that people will be invested in crypto, so I will list each and outline what I think the situation would be in each. We have:
In personal cold storage
On an exchange, such as Binance
Via an intermediary, such as Revolut or [I think] Coinbase
This may be completely wrong, but I'm outlining my understanding in order to clear it up.
1. Personal cold storage
In this case I believe that USDT has no role in the process of owning the crypto, and cryptocurrencies are simply passed from one wallet to another in a transaction. If USDT went to zero, then there would be no problem for these people.
I think that on exchanges you need to first convert fiat USD into USDT, which can then be used to exchange into cryptocurrency. Similarly, you need to convert your cryptocurrency into USDT before you can then convert it to fiat to remove any balances. If USDT went to zero, then the crypto that is 'owned' could not be converted back to fiat.
In this case I would guess that the company (e.g. Revolut) would own the cryptocurrency on the exchange, and then any returns are paid to the Revolut account holder who has 'invested' in crypto. If USDT goes to zero, then these companies will not be able to pay the value of the crypto to the account holder.
Impact on the value of crypto
This isn't clear to me and is probably more up for debate than the impact on holders of crypto. My initial thought is that there is less liquid crypto in circulation, which would put upward pressure on prices. On the other hand, such a clear systemic risk to the industry could put downward pressure on prices.
Is my assessment of each of the methods above valid?
Is my assessment of what would happen to the holders of crypto if USDT went to zero valid?
Thoughts on the impact on the value of cryptocurrency if such an event occurred?