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Why Do Stablecoins Depeg From Their Intended Value?

Last Updated January 31, 2024 2:24 PM
Alisha Bains
Last Updated January 31, 2024 2:24 PM

Key Takeaways

  • Stablecoins serve as a reliable unit of account, medium of exchange, and store of value in the cryptocurrency market.
  • Notable depegging incidents include Tether, USD Coin, Dai, TrueUSD, and TerraUSD, revealing vulnerabilities in their stability mechanisms
  • Stablecoin depegging can be influenced by market dynamics, governance challenges, and vulnerabilities in smart contracts.
  • Mitigation strategies involve implementing decentralized governance, enhancing transparency through regular audits, real-time reserve disclosures, and open communication channels.

Purpose Of Stablecoins And Their Intended Value

A stablecoin is a type of cryptocurrency whose value is tied to an underlying asset or group of assets to reduce price volatility. Stablecoins are primarily intended to offer a more reliable unit of account, store of value, and medium of exchange in the volatile crypto market.

Stablecoins are an attempt to offer a dependable unit of account, medium of exchange, and store of value by tying their value to fiat currencies, commodities, or algorithmic processes. 

For them to be widely used in regular transactions, international payments, and as a risk management tool for traders navigating the volatile cryptocurrency market, they must remain stable. 

Stablecoins are also essential to decentralized finance (DeFi) applications because they support smart contracts, which automate a range of financial activities.

Stablecoins are an entry point for newcomers into the cryptocurrency industry because of their ease of use and resilience to sharp price swings. This promotes greater accessibility and integration with conventional financial institutions. 

History Of Stablecoin Depegging Events

Despite their stability mechanisms, several stablecoins have faced depegging events, including:

Tether (USDT)

Although Tether (USDT) has come under fire on several occasions over the years, one particularly worrying moment occurred in October 2018, when worries regarding the sufficiency of Tether’s dollar reserves and its banking connections caused USDT’s value to plummet to approximately $0.85 on certain exchanges.

A notable event occurred on August 7, 2023, at approximately 8 am UTC, when USDT traded on nearly all trading platforms at a 2% discount to its anticipated $1 peg. Reports indicate over $500 million in net selling of USDT across well-known cryptocurrency exchanges including Binance, Huobi, and Uniswap set off this depegging event.

USD Coin (USDC)

On March 11, 2023, USDC lost its peg to the US dollar. The coin’s value decreased from $1 to a low of $0.887. With a 15% loss, the token’s market capitalization fell below $40 billion. Depegged coins included DAI and Frax, which were also stable coins backed by USDC.

Dai (DAI)

Dai has seen multiple instances of instability, especially during periods of intense market volatility. One such occurrence occurred on “Black Thursday” in March 2020, when the MakerDAO system experienced huge liquidations due to the Ether (ETH) price fall, and Dai momentarily traded over its $1 peg.

TrueUSD (TUSD)

The early redemption issue that caused a brief depegging for TrueUSD occurred shortly after its launch in 2018, but it was quickly resolved.

UST (TerraUSD)

The most catastrophic depegging event in recent history occurred with TerraUSD (UST) in May 2022, when it dramatically lost its peg to the US dollar, leading to a domino effect that crashed the value of its sister token LUNA and caused significant turmoil in the broader cryptocurrency market.

Factors Influencing Stablecoin Depreciation

There are several factors leading to stablecoin depegging, such as:

Market Dynamics 

Stablecoin fluctuations from their pegged value can be attributed to market dynamics and changes in investor opinion. Market dynamics may be impacted by external variables such as macroeconomic shifts, regulatory reforms, or world events.

Supply And Demand Fluctuations

Variations in the stablecoin’s supply and demand may cause it to deviate from its fixed price. The coin’s intended pegged value may not be reached if there is an abrupt change in demand without a corresponding adjustment to the coin’s supply.

Liquidity Issues 

The stability of the stablecoin may be hampered by a lack of market liquidity, particularly in times of extreme volatility. Wider bid-ask spreads brought on by limited liquidity could make it difficult for the stablecoin to trade at its intended value.

Governance And Management 

In both centralized and decentralized systems, the set of procedures, guidelines, and decision-making frameworks that steer the course and management of the entity—be it a business, organization, or decentralized network—are referred to as governance.

Centralized Vs. Decentralized Governance

Stability in a centralized governance architecture can be exacerbated by a single point of failure and a lack of transparency. The governing body’s regulatory issues or poor decisions could make the stablecoin’s peg less credible.

On the other hand, decentralized governance, which divides up decision-making among stakeholders, can improve inclusion and resilience. But delays in decision-making and coordination could occur, which would affect the stablecoin’s capacity to hold onto its peg.

Macroeconomic Events

Stablecoins may be under strain from macroeconomic events like periods of economic instability or global financial crises. 

Economic Crises

A stablecoin may stray from its peg as a result of rising demand for stable assets during economic downturns. 

Inflationary Pressures 

Stablecoins linked to fiat currencies may be impacted by inflationary pressures, which could result in depegging events as consumers look for more reliable places to store their money.

Regulatory Changes

Uncertainties can be introduced by changes in legal challenges and regulatory settings, which might impact stablecoin stability. 

Legal Challenges

Strict regulatory oversight or abrupt modifications to legislative frameworks could disrupt market dynamics and have an effect on the stablecoin’s capacity to stay pegged. 

Government Intervention

Legal difficulties, such as litigation or government investigations, can cast consumers in doubt and hasten depegging.

Smart Contract Vulnerabilities

Stablecoin integrity may be jeopardized by smart contract technical flaws and code exploits. 

Code Exploits

A stablecoin depegging due to a code exploit typically occurs when vulnerabilities or weaknesses in the smart contract code of the stablecoin are exploited by malicious actors. These vulnerabilities could be unintentional errors, oversights, or weaknesses in the code logic.

Security Breaches 

Stealing or malevolent attacks can lead to security lapses that manipulate stablecoin balances, resulting in abrupt depegging. If users believe that the coin’s underlying technology is vulnerable, they start to lose faith in the stability of the coin. 

Blockchain Network Issues

Blockchain network issues could undermine trust in the stablecoin’s peg and impair its usage.  

Congestion And Scalability

Transaction delays and higher fees can result from technical problems with the blockchain network, such as scalability and congestion. 

Network Failures

Stablecoin operations may be interfered with by network outages and malfunctions, which could lead to depegging incidents.

Strategies To Mitigate The Risk Of Stablecoin Depegging 

Improved Governance Models 

Resilience can be increased by implementing decentralized governance models that incorporate community involvement and decision-making. By sharing decision-making authority, this lowers the possibility of a single point of failure and encourages diversity in governance.

Implementing procedures that enable quick and efficient reactions to changes in the market or outside events is also essential. This includes adaptable governance frameworks that can act quickly to resolve new issues and keep the stablecoin pegged.

Moreover, consistent audits of governance procedures and systems can spot possible flaws and fix them. By hiring independent auditors to evaluate the governance structure, you can increase its legitimacy and make sure it’s resistant to threats.

Enhanced Transparency Measures

Transparency is enhanced by routinely auditing the stablecoin’s operations, smart contracts, and reserves. The release of these financial documents and audit reports bolsters user confidence in the stablecoin’s stability.

By making the reserves supporting the stablecoin available in real time, users can confirm that the coin is pegged and that it is sufficiently collateralized. This openness increases credibility and allays concerns about the coin’s stability.

Furthermore, creating transparent and open channels of contact with the community aids in the information-sharing process regarding market dynamics, governance decisions, and possible obstacles. Open communication helps users stay informed and fosters trust.

Legal risks can be reduced by making sure that regulations are followed and by keeping financial transactions transparent. 

Conclusion

Depegging is a constant issue for stablecoins, which are intended to provide stability in the erratic cryptocurrency market. Vulnerabilities are highlighted by historical occurrences such as the debates surrounding Tether and the disastrous depegging of TerraUSD. Instability is caused by a number of factors, including smart contract vulnerabilities, governance problems, and market dynamics. 

Decentralized governance models, responsive procedures, and increased transparency measures must be put in place in order to reduce risks. Resilience is increased through open communication, real-time reserve disclosures, and routine audits. 

For newcomers, stablecoins continue to be crucial since they provide accessibility and easy integration into traditional financial systems; but, their long-term viability depends on careful governance and risk management techniques.

FAQs

What is the purpose of stablecoins?

Stablecoins aim to provide stability in the volatile cryptocurrency market by offering a dependable unit of account, medium of exchange, and store of value.

Why have stablecoins faced depegging events?

Stablecoins have faced depegging due to factors such as market dynamics, liquidity issues, smart contract vulnerabilities, regulatory changes, and macroeconomic events.

Which stablecoins experienced depegging events?

Tether (USDT), USD Coin (USDC), Dai (DAI), TrueUSD (TUSD), and TerraUSD (UST) are examples of stablecoins that have experienced depegging events.

How can the risk of stablecoin depegging be mitigated?

Mitigating strategies include implementing improved governance models, especially decentralized governance, and enhancing transparency through regular audits, real-time reserves disclosure, and open communication.

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