Stablecoins are often described as the calm center of the crypto market. While most digital assets swing wildly in price, stablecoins are designed to remain steady, typically tracking the value of a fiat currency like the US dollar. Yet history has shown that this stability is not guaranteed. When confidence breaks, liquidity dries up, or design flaws surface, stablecoins can drift away from their intended value. This phenomenon is known as depegging.
Understanding why stablecoins depeg requires looking closely at how pegs work in practice, how different stablecoin models manage risk, and what happens when real-world stress tests expose their weaknesses.
What a Stablecoin Peg Really Means
A stablecoin peg acts as a reference point for value. Most stablecoins aim to trade at a fixed price, commonly one US dollar. To maintain that price, issuers rely on a mix of collateral, market incentives, and redemption mechanisms. In theory, if a stablecoin drops below its peg, traders buy it cheaply and redeem it for the underlying asset, pushing the price back up. If it trades above the peg, new tokens can be issued to increase supply and cool demand.
This balancing act works smoothly only as long as markets trust the system behind it.
What Happens During a Depegging Event
A depegging event occurs when a stablecoin trades consistently above or below its intended value. Even small deviations can cause panic, especially given how deeply stablecoins are woven into trading, lending, and payments across crypto markets. When confidence falters, redemptions accelerate, liquidity thins out, and price stability can unravel faster than many expect.
To see why this happens, it helps to look at how different stablecoin models attempt to hold their peg.
How Stablecoins Try to Stay Stable
Most stablecoins fall into two broad categories: collateralized and non-collateralized.
Collateralized stablecoins are backed by assets held in reserve. Fiat-backed versions rely on cash or cash-equivalent instruments, promising that every token can be redeemed for real dollars. Examples include USDT and FDUSD. As long as reserves are liquid and fully accessible, the peg tends to hold.
Crypto-collateralized stablecoins take a different approach. Instead of fiat, they use digital assets as backing, often holding more collateral than the value of the stablecoins issued. This overcollateralization provides a buffer against price swings, but it also introduces exposure to crypto market volatility. DAI is one of the most well-known examples of this model.
Commodity-backed stablecoins are tied to real-world assets such as gold. PAXG, for instance, represents ownership of physical gold stored in vaults. While this structure can hedge against inflation, liquidity and redemption logistics still matter.
Non-collateralized, or algorithmic, stablecoins rely almost entirely on code. Instead of reserves, algorithms expand or contract supply based on market demand. When prices dip, supply is reduced. When prices rise, new tokens are minted. The idea is elegant, but it assumes continuous market confidence. Once that confidence breaks, algorithms alone may not be enough to stop a collapse.
When the Peg Breaks: Real-World Examples
The most dramatic stablecoin failure occurred in May 2022 with TerraUSD. UST relied on an algorithmic relationship with its sister token, LUNA. When selling pressure mounted, the mechanism designed to stabilize UST instead amplified the collapse. As UST fell below its peg, LUNA was minted in massive quantities, destroying its value and triggering one of the largest failures in crypto history. The fallout spread quickly, shaking confidence across the entire market.
In March 2023, a different kind of stress test hit USDC. The issue was not an algorithm but counterparty risk. A portion of USDC’s reserves was held at Silicon Valley Bank, which collapsed during a broader banking crisis. When this exposure became public, USDC briefly lost its peg, dragging DAI down with it due to shared collateral links. Stability returned only after decisive intervention from US regulators reassured markets that depositors would be made whole.
Later that year, another cautionary tale emerged with USDR. Backed partly by tokenized real estate, USDR faced a surge in redemption requests that quickly exhausted its liquid reserves. The remaining collateral was illiquid and difficult to convert on short notice. As redemption delays mounted, fear spread and the peg broke. The episode highlighted a key lesson: not all collateral is equal, especially during moments of stress.
The Deeper Lessons Behind Depegging
Across these cases, a common pattern emerges. Stablecoins depend not just on assets and code, but on trust, liquidity, and timing. Pegs tend to break when reserves are inaccessible, when collateral loses value too quickly, or when market participants rush for the exit at the same time.
Design choices matter. Algorithmic models struggle without credible backstops. Fiat-backed models depend heavily on the safety of traditional financial institutions. Asset-backed systems must balance yield generation with the need for immediate liquidity.
Final Thoughts
Stablecoins play a critical role in the crypto ecosystem, acting as bridges between volatile digital assets and the traditional financial world. Yet they are not risk-free. History has shown that even widely used stablecoins can falter under pressure, whether due to flawed design, hidden exposure, or sudden liquidity shocks.
For anyone using stablecoins, understanding how a peg is maintained is just as important as understanding what happens when it breaks. In crypto, stability is not a promise-it is a mechanism, and every mechanism has limits.
