People are stupid, they know Tether is most likely not fully backed, yet don't care but still use it to move fiat from one exchange to another. People will feel the pain when their Tethers will become worthless, that's when they will regret selling one of the most precious assets in the world for something shittier than the real dollar.
as long as
some people can redeem tethers for real dollars, arbitrage will keep the market in line. that's the magic of tether. they don't need to be fully backed. they just need enough money flow to justify arbitrage.
really, this is no different than an insolvent exchange---and there are (and have been) many of those. "real dollars" didn't mean much on mt gox either. like a bank balance before a bail-in, they are just numbers in a database subject to change at any time.
Most people don't need super high liquidity. Exchanges such as Binance support USDC pairs that generate enough volumes for the far majority of the traders. You can't prevent people from doing stupid things, but at least using USDC instead of Tether is less stupid.
i use the USDC market but tbh, i'm a small fry and i still experience disappointing slippage. sometimes market ordering into walls is the only way i can get enough liquidity. if i were just 2-3x bigger, i would need to either use USDT or go legit somewhere liquid like coinbase pro.
