Depegging means when something acts like a dance, For example, cryptocurrencies, commodities, etc. Prices move up and down from their stable price like from 1$ to 0.9$ or 0.9$ to 1.1$.
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Today we will discuss this amazing topic in very deep and simple terms so let’s start.
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Let’s Dive deeper to understand this concept:
A depeg refers to when a cryptocurrency breaks its peg to another asset it was supposed to be valued at. Some cryptocurrencies are designed to be pegged, or tied, to the value of another currency like the U.S. dollar or another crypto.
For example, a stablecoin may be pegged to always be worth $1 USD. If the price of that stablecoin drops below $1, like to $0.98 for instance, it is now trading below its peg and has become depegged. This is sometimes called “breaking the peg” as the stablecoin’s value is no longer pegged to the dollar as intended.
Depending on the cryptocurrency and its design, a depeg event can lead to a loss of trust and confidence. If a stablecoin fails to hold its peg, it may lead holders of that coin to sell out of concern that the peg will not be restored.
The reasons for a depeg event can vary but often have to do with issues backing the cryptocurrency’s value, or changes in market supply and demand. Some depeg events are temporary, while others can be more sustained if trust has eroded.
Now let’s understand why this happens if their design is already fixed:
There are a few potential reasons a cryptocurrency can lose its peg, resulting in a depeg event let’s discuss this in some deep way:
- Lack of reserves backing the stablecoin – Some stablecoins are backed by reserves of fiat currency or other assets. If those reserves run low or are improperly managed, it can cause the peg to break as there’s insufficient backing to maintain the intended price.
- Changes in demand – If demand for a stablecoin shrinks, but supply remains the same, it can lead to downward pressure on the price and cause a depeg from its $1 value. Likewise, a surge in demand could push the price over $1.
- Speculation – If traders believe a depeg is likely, they may sell positions in the stablecoin or short it. This speculative selling pressure could then cause the peg to break.
- Technical problems – Issues with the computer code or mechanisms meant to maintain the peg could lead to a failure to keep the price fixed. This is primarily a risk for algorithmic stablecoins.
- Lack of confidence – If holders of a stablecoin lose trust that the peg will hold, they may rush to sell. This self-fulfilling loss of confidence can then lead to a depeg.
- Regulatory action – Regulators stepping in to restrict or ban trading of a stablecoin could also lead to a loss of trust and a depeg event.
The reasons vary but often come down to weaknesses in reserves, changes in supply/demand, or a loss of confidence in the stability of the peg. A depeg doesn’t necessarily mean a stablecoin has failed in the long run, but it does erode trust.
Here are a couple of real-world examples that show how stablecoins can lose their dollar peg and experience a depeg event:
This algorithmic stablecoin was pegged to $1 USD and relied on a complex system of minting and burning coins to maintain its peg. In May 2022, UST lost its $1 peg as a result of a bank run where many holders rushed to sell their UST. This flooded the market, pushed the price down to $0.30, and caused a depeg.
USDT has maintained its peg for the most part but did experience periodic depegging in its early history due to insufficient reserves. In October 2018, USDT briefly fell below $0.95 due to concerns about whether Tether had enough USD reserves to back all USDT coins in circulation.
Dai Stablecoin (DAI)
DAI aims for a soft peg to the U.S. dollar and has maintained it through over-collateralization with other crypto assets. However, in March 2020 at the height of COVID-19 uncertainty, DAI rose above $1.20 briefly as volatility led its soft peg to break.
Neutrino USD (USDN)
This algorithmic stablecoin aims to maintain its $1 peg by algorithmically adjusting supply based on demand. However, in June 2022 it lost its peg and fell to $0.93 due to not having sufficient bitcoin reserves to back the supply adjustment mechanisms. This meant when demand spiked, the algorithms could not mint and sell enough new USDN to raise funds to defend the peg. The technical limitations and insufficient reserves caused it to depeg.
Paxos Standard (PAX)
PAX is backed 1:1 with USD reserves held in bank accounts. However, in March 2020 at the start of the COVID-19 pandemic, intense demand for liquidity and cash caused strains on reserves that briefly pushed PAX down to around $0.95. Paxos had to rapidly inject new reserves to absorb the selling pressure and defend the peg. This demonstrated the challenges of maintaining sufficient reserves even for asset-backed stablecoins during crisis events.
STASIS Euro (EURS)
EURS is pinned to the Euro, with each coin valued at 1 Euro and backed by euro currency reserves. However, in March 2020, global demand for dollars caused the Euro to depreciate against the USD. This caused the dollar-denominated price of EURS to decline from $1.10 to around $0.90, even though its Euro peg held. This shows the complexity of maintaining a peg when the asset it tracks is fluctuating.
In each case, the root cause was different – whether a bank run, reserve concerns, or market volatility. But in all cases, the result was a loss of the peg that was supposed to keep these stablecoins valued at $1 USD. When the peg slipped, it shook confidence in the stability and utility of the coins.
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