What a depeg is
A depeg happens when a stablecoin trades meaningfully away from its target price, usually below one dollar. Small, brief deviations of a fraction of a cent are common and usually fade. The events discussed here are larger: cases where confidence in the backing or the mechanism was questioned, and the price moved far enough to cause real losses or alarm.
Looking at past cases is useful because each one tested a different weakness. The design types are laid out in the stablecoins explained pillar, and this article uses real episodes to show where the weaknesses appear. Only well-documented cases are described, and details are kept general.
TerraUSD, May 2022
TerraUSD, known as UST, was an algorithmic stablecoin. It did not hold dollar reserves against each token. Instead, it was linked by a rule to a companion token, LUNA: users could exchange one dollar’s worth of UST for one dollar’s worth of LUNA, and the reverse. The idea was that arbitrage would keep UST near a dollar.
In May 2022 UST lost its peg. As it fell, more people exchanged it for LUNA, which increased LUNA’s supply sharply and pushed its price down, which in turn weakened the thing meant to support UST. The result was a feedback loop in which both tokens collapsed to a tiny fraction of earlier values within days. Large losses followed for holders, and the wider market also fell, with effects on lenders and other firms that were exposed.
The lesson is about design: a peg that relies on confidence in a companion asset is vulnerable exactly when confidence is lost. There was no separate pool of assets to fall back on. A high yield offered on the stablecoin was also a feature that drew attention at the time, and unusually high advertised returns are generally a reason for more caution, not less.
USDC, March 2023
USDC is a fiat-backed stablecoin whose issuer, Circle, published that part of its cash reserves was held at Silicon Valley Bank, which failed in March 2023. For a short time it was unclear whether those deposits could be accessed, and USDC traded well below a dollar on exchanges before recovering once authorities announced they would protect depositors and the uncertainty eased.
The case is different in kind. The token had real reserves, but part of them sat with a single bank that ran into trouble. It shows that reserve quality involves custody and concentration as well as total size, which ties back to the points in the article on stablecoin reserves. It also shows that a peg can wobble even for a fully backed token when access to the assets is in doubt, and that this kind of risk is a form of counterparty risk.
Other episodes worth knowing
DAI, March 2020. DAI is a crypto-backed stablecoin. During a sharp market fall in March 2020, collateral values dropped quickly while network congestion made it hard for users to add collateral. Liquidations ran into difficulties, and DAI traded above its target for a period, an example that depegs can occur in either direction. The system later made changes to its collateral rules. High gas fees during congestion were part of the practical difficulty.
Iron Finance, June 2021. A partly collateralized, partly algorithmic token called IRON lost its peg when large holders sold and a related token fell sharply, setting off a run. It was an early example of the same reflexive loop later seen at much larger scale.
Tether, 2022. During the turmoil of May 2022, USDT, the largest dollar token by supply, also dipped below a dollar for a time before recovering. Questions about its reserve disclosures have been raised on and off over the years, which is why the details of reporting matter.
Several smaller algorithmic tokens have also failed. The pattern across the group is that depegs tend to cluster in periods of market stress.
What the cases suggest
Taking the episodes together, a few themes appear.
- Backing matters most when it is tested. A design can look stable for long periods and fail rapidly. Calm conditions reveal little.
- Reserve liquidity and custody matter. Total assets alone do not say whether holders can be paid quickly.
- Redemption access shapes the peg. If only some participants can redeem at par, others depend on the exchange price.
- Reflexive designs are fragile. Where the value of the support depends on the confidence the stablecoin itself creates, stress can feed on itself.
- Depegs spread. Losses at one token can ripple through lenders, exchanges and trading pairs. Selling pressure during these events can also feed a liquidation cascade for leveraged positions.
Reading depegging risk
Depegging risk cannot be eliminated or reliably predicted, but a few habits reduce exposure. Understand what backs a token and how redemption works. Avoid concentrating funds in one issuer. Be cautious about products that promise high returns for holding stablecoins. And remember that a price near one dollar today does not guarantee the same tomorrow.
Past events are not a forecast, and each failure had its own details. Crypto assets can lose value quickly, and people can lose everything they put in. This article is educational and is not financial, tax or legal advice.