What is Stablecoin Peg?

What is Stablecoin Peg? – A stablecoin is a form of cryptocurrency that aims to maintain a steady value. Unlike most cryptocurrencies, stablecoins are designed to minimize price fluctuations and provide a safeguard against volatility.

Stablecoins ensure stability through a “peg,” which acts as a value anchor. Similar to how countries link their currency’s value to another nation’s currency for stability, stablecoins follow a similar approach. Popular stablecoins such as USDT and DAI strive to maintain a value equivalent to $1.

What occurs when a stablecoin loses its peg?

A stablecoin is referred to as a “depegging event” when it no longer trades at its fixed peg value. Stablecoins have gained significant usefulness over time and currently contribute to billions of dollars in daily trading volume. A depegging event could have significant consequences.

How is the value of a stablecoin kept stable?

Stablecoins usually fall under two categories – collateralized and non-collateralized.

Collateralized

The majority of stablecoins currently in circulation are collateralized stablecoins. This means that their values are supported by other assets. These stablecoins are designed to be backed or “collateralized” by fiat currencies, other cryptocurrencies, or commodities such as gold. In such instances, each stablecoin that is issued should ideally have a corresponding asset held in reserve.

Here is how they work:

  • Fiat-collateralized
  • Crypto-collateralized
  • Commodity-collateralized

Non-collateralized

Non-collateralized stablecoins, also referred to as algorithmic stablecoins, employ coded algorithms and smart contracts to automatically adjust their supply according to market demand. This ensures that the stablecoin’s price stays near its peg.

If the price falls below the value of the fiat currency it follows, the algorithm decreases the amount of circulating supply to try to increase the price again. Conversely, if the price exceeds the value of the fiat currency, new tokens are introduced to lower the value of the stablecoin. TerraUSD (UST) was a stablecoin based on algorithms.

Historical Examples of Stablecoin Depegging

Below are a few examples of well-known cases where stablecoins have experienced depegging:

  • May 2022 – UST
  • March 2023 – USDC and DAI
  • October 2023 – USDR
  • January 2024 – TrueUSD

Conclusion

In the ever-changing realm of cryptocurrencies, stablecoins have provided a sense of security for investors seeking stability. Nevertheless, it is important to acknowledge that these stablecoins are not immune to difficulties, as demonstrated by the significant depegging incidents of UST and USDR. These incidents highlight their vulnerability to external financial pressures and inherent flaws in their design. Just like with any investment in the financial markets, conducting thorough research is essential before taking any risks.