What is a stablecoin depeg?
A stablecoin depeg in plain words
A stablecoin, that is, a digital dollar on a blockchain, is usually worth about one dollar because reserves or collateral stand behind the tokens. The issuers of USDT and USDC, the companies that release them, promise to exchange each token for a dollar. The English word "peg" means a stake or a fixing point, and a depeg is when the price slips off that stake.
Picture a $100 gift card from a store. While the store is open and accepts the cards, people resell them for almost their face value. Then a rumor spreads that the store is closing, and card owners start selling them for $90 or $80, just to get something back. If the store reopens, the card's price returns to $100. If it goes bankrupt, the card may be worth nothing.
What keeps the price at the dollar is exchange with the issuer. Mostly it is the company's large verified customers who exchange directly with it, although in Europe any holder can exchange USDC and EURC as well ⚖️; what are reserves goes into this in more detail. If the token trades at, say, 98 cents on an exchange, such a customer buys it cheaper and exchanges it with the issuer for a dollar1. Demand for the cheap tokens lifts the price back up, and as long as this exchange works and the issuer is trusted, any big drop below the dollar is usually bought up quickly.
What a holder should do during a depeg
What should you do if your stablecoin depegs?
When this happens to your stablecoin, take your time: first find out the cause, and only then decide whether to sell or wait.
- Find the issuer's official announcement on its website or its official accounts, and compare it with news from serious outlets.
- Find out whether you yourself can exchange the token with the issuer. If not, your way back to dollars is selling at the current price on an exchange or to other people.
- Compare the price across several platforms; sites that collect prices from different exchanges show it. where to check: a price-aggregator site, e.g. coinmarketcap.com
- Keep in mind that an exchange may temporarily stop converting the stablecoin into dollars. Coinbase, for example, paused USDC-to-dollar conversions over the weekend of 11 to 12 March 2023, while banks were closed2.
- Do not reply to messages promising to "exchange at one dollar" or "save your money", and never enter your seed phrase, the words that restore your wallet, on any website. How to spot such schemes is covered in phishing and scams.
Will a stablecoin's price return to the dollar after a depeg?
There is no guarantee that a stablecoin's price will return to the dollar; it all depends on what caused the depeg. The price came back when the reserves were in place and the issuer was again exchanging tokens for dollars: within a day for USDT in May 2022, and over a weekend for USDC, once the bank's deposits were promised back. UST had no reserves, and its price did not recover.
Why a stablecoin loses its peg
A depeg starts when exchange with the issuer stops holding the price, or when holders doubt that it will work. Most often one of these causes is behind it:
- the reserves fall short, or part of them cannot be reached, for example when money is stuck in a failed bank;
- exchange with the issuer has stopped for a while, and customers cannot hand tokens back for dollars even though the reserves are in place;
- many holders want out at the same time, and selling on exchanges outpaces exchange with the issuer;
- the stablecoin holds its price only by swapping into another cryptocurrency of its own network, and there is no money behind it;
- the stablecoin is backed by another stablecoin, and a depeg in one drags the other down.
The UST depeg in May 2022
UST held its price through exchange for LUNA, the own cryptocurrency of the same Terra network. For one UST the program always handed out one dollar's worth of LUNA, however many LUNA coins that took, and the other way round3. In May 2022 UST was hit by heavy selling, and holders swapped it for LUNA en masse. The more UST was swapped, the more LUNA was created, and within a few days LUNA's price fell almost to zero. UST lost most of its value, and the Terra network was halted3. Even a bitcoin reserve worth billions of dollars, kept to defend the price, did not save it4.
Why do algorithmic stablecoins lose their peg more often than others?
An algorithmic stablecoin has no reserves outside its own system. LUNA's value rested on demand for UST, so when people stopped believing in UST, the coin used to exchange it fell too. Once all LUNA coins together were worth less than all the UST in holders' hands, giving a dollar in LUNA for every UST became impossible3. Reserves in dollars and government bonds do not depend on the price of the token itself, which is why stablecoins with such reserves are considered more stable than algorithmic ones3.
The USDT depeg on 12 May 2022
Amid the panic around UST, on 12 May 2022 USDT briefly traded at about 95 cents on some exchanges. Tether kept paying its verified customers a dollar per token, and by the afternoon the price was almost back at the dollar5. Over two days holders handed Tether tokens worth about 7 billion dollars, and the company paid out the money for them6.
The USDC and DAI depeg in March 2023
On 10 March 2023 the US bank Silicon Valley Bank was shut down, and 3.3 billion dollars of USDC reserves got stuck there7. On Saturday, 11 March, the token's price dropped below 87 cents8. During those days USDC could not be exchanged with Circle, because exchange works only during US banking hours1.
DAI, part of whose collateral was held in USDC, lost its peg next, and that same night it fell below $0.909. On 12 March the US authorities promised to return all of the bank's deposits to its customers10, and on 13 March USDC was again worth about $0.9911.
More detail on the numbers behind three depegs
At its peak, about 18 billion dollars' worth of UST was in circulation3. From 10 to 12 May 2022 the number of LUNA grew roughly 80-fold, and its price fell from 31 dollars to one cent3. The reserve of roughly 80,000 bitcoins was held by the Luna Foundation Guard, and almost all of it was spent buying up UST4.
The money stuck at Silicon Valley Bank made up almost 8% of all USDC reserves, which totaled about 40 billion dollars at the time8. At that point roughly 36% of DAI's collateral consisted of USDC9.
