Depeg is the name given to the situation when the stablecoin deviates from its pegged price. Curve Finance’s trading volume peaked at $7 billion after the USDC depeg. The depeg also set the stage for a 5% drop in MakerDAO’s DAI stablecoin. So what is depeging, why does it happen?
What is Depeg?
Depeg means that the stablecoin, whose value is pegged to the US dollar, deviates from this value. When the event, also called depeging, occurs, the existence of that stablecoin begins to be questioned. It has been observed that the value constant of many leading stablecoins in the crypto money market has deteriorated to date. These include leading stablecoins such as Tether, USDC, BUSD and GUSD.
Especially in algorithmic stablecoins whose value is fixed by codes and mathematical calculations, depegs can be disastrous.
Recently, the industry has experienced this situation with the deterioration of the dollar peg of Terraform Labs’ algorithmic stablecoin Terra USD (UST). Billions of dollars were wiped from the cryptocurrency market following the depeging of the UST, with investors facing serious losses. This created a domino effect for the crypto industry and crypto companies began to go bankrupt one after another.
How and Why Does Depeg Happen?
The Depeg event happens because of incompatible reserves and markets outperforming the algorithm. If the value of a stablecoin is not supported 100% by the asset it is linked to, the price will diverge. For there to be no depeg, the market must provide full reserve support to the stablecoin.
On the other hand, the value of an asset through supply and demand. Even if its fixation is secured, the sustainability of this situation may be impaired. That is, when the market performs better than the algorithm or experiences a rapid collapse, the stablecoin deviates, that is, depeging.
So, how to prevent depeg? In order to prevent this event, which has serious consequences, first of all, legal regulations are needed. Regulations play a critical role in providing support with adequate reserves. Otherwise, stablecoins will be no different from the money that is printed for free.
The existence of strong arbitrage mechanisms is among the things to be done to avoid depeging. Thus, a layer of protection will be added on the smart contract management of algorithmic stablecoins. When a stablecoin is trading below a dollar, arbitrageurs can buy it cheap, then trade it for $1, making a profit and getting it to recover the dollar stable.
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