Due to the recent collapse of Terra's LUNA token following its stablecoin UST's depegging event, there's growing interest in understanding how stablecoins maintain price pegs, what pegging means, and why stablecoins might lose their pegs.
In 2021, the stablecoin market cap surpassed $100 billion, with USDT becoming the third-largest cryptocurrency by market capitalization. Stablecoins combine the stability of fiat currencies with the borderless and decentralized nature of cryptocurrencies, offering practical utility. They're widely adopted for cross-market value transfers, remittances, and more.
Different Types of Stablecoins
To understand peg maintenance, we must examine the various stablecoin models:
Collateralized Stablecoins
Backed by reserves of fiat currency, cryptocurrencies, or commodities, collateralized stablecoins ensure stability through asset backing. Examples include:
Fiat-Collateralized (e.g., USDT)
- Each USDT is backed 1:1 by USD reserves held off-chain by Tether.
- Users deposit USD into Tether’s bank account to mint USDT, ensuring circulating supply matches reserves.
Crypto-Collateralized (e.g., DAI)
- Overcollateralized with assets like ETH to buffer against volatility.
- Smart contracts manage collateral ratios to maintain DAI’s $1 peg.
Commodity-Collateralized (e.g., PAX Gold/PAXG)
- Pegged to physical assets (e.g., gold).
- Enhances accessibility but may face liquidity challenges vs. fiat-backed options.
Algorithmic Stablecoins
These use smart contracts to algorithmically adjust supply/demand:
- Mechanism: Incentivizes arbitrage (e.g., burning LUNA to mint UST when price >$1).
- UST’s Collapse: Massive withdrawals overwhelmed Terra’s algorithm, causing a death spiral as UST depegged and LUNA’s value plummeted.
👉 Learn how arbitrage stabilizes algorithmic stablecoins
Why Stablecoins Lose Their Pegs
Key factors include:
- Collateral Insufficiency: Fiat-backed stablecoins face scrutiny over reserve audits (e.g., USDT’s transparency concerns).
- Market Panics: Sudden liquidity crushes (e.g., UST’s bank-run scenario).
- Algorithm Failures: Over-reliance on arbitrage incentives without fail-safes.
FAQs
1. What does "pegged" mean for stablecoins?
A peg refers to a stablecoin’s fixed exchange rate (e.g., 1 USDT = $1), maintained via collateral or algorithms.
2. Can algorithmic stablecoins recover from depegging?
It’s rare—UST’s collapse shows vulnerabilities in pure algorithmic models without collateral backing.
3. Are fiat-backed stablecoins fully secure?
While more stable, they depend on centralized reserves, posing counterparty risks if reserves are mismanaged.
👉 Explore secure stablecoin strategies
4. How does overcollateralization work?
DAI requires >100% collateral (e.g., $150 ETH to mint $100 DAI), cushioning against crypto price swings.
5. What caused Terra’s LUNA to crash?
UST’s prolonged depegging eroded trust, triggering LUNA sell-offs as the system relied on LUNA burns to stabilize UST.
Conclusion
Stablecoins balance innovation and risk. While collateralized models dominate, algorithmic variants highlight the need for robust mechanisms. Diversification and transparency remain critical for long-term stability.