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What is a stablecoin depeg?
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The basics of a stablecoin depeg: what influences the price of a centralized stablecoin ?
stablecoin , such as USDT USDT Tether) or USDC USDC Circle), are designed to maintain a stable value, usually set at $1. This stability relies on physical reserves held by the centralized issuer. These reserves include bank deposits, government bonds, or other traditional financial assets. Each stablecoin in circulation is supposed to be fully backed by an equivalent asset, guaranteeing its nominal value. However, the mechanism that maintains this link relies heavily on the trust of investors and traders in the reserves held .
Maintaining the anchor through arbitration
The stability of stablecoin on the secondary market is primarily maintained by arbitrage traders stablecoin 's market price and its $1 face value. This process relies on the trust that each stablecoin can be exchanged for $1 with the issuer. Here's how this mechanism limits the risk of depeg :
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If the stablecoin trades above $1 : Traders buy the underlying asset (e.g., dollars ) from the issuer and sell stablecoin on the market. This increase in supply causes the price of the stablecoin until it returns to its parity.
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If the stablecoin falls below $1 : Traders buy stablecoin at a discount on the secondary market, then exchange them directly with the issuer for their face value of $1. This process reduces the market supply and raises the price back up to $1.
This mechanism relies on the ability of issuers like Tether or Circle to guarantee that stablecoin can be redeemed at any time for $1 in underlying assets. This implies that traders have complete confidence in the strength and liquidity of the issuer's reserves .
Who can directly exchange USDT for dollars using Tether?
In practice, only large institutional players or verified entities can directly exchange their USDT for dollars on Tether . These exchanges require going through a verification process and meeting a minimum redemption threshold, often set at several thousand or even millions of dollars. Individuals cannot directly access this mechanism. They must turn to secondary markets to buy or sell their stablecoin . This centralized model means that the confidence of individual traders indirectly relies on the activity of large arbitrage opportunities , which themselves depend on Tether's ability to honor redemptions.
Role of reserves and impact of blocked reserves
Reserves play a central role in preventing the depeg of a stablecoin . They serve to guarantee that a user can exchange their stablecoin for dollars (or other underlying assets) at any time. This link between the quantity of stablecoin in circulation and the assets held in reserve acts as value insurance , incentivizing traders to maintain parity.
However, if a significant portion of the reserves is frozen or becomes inaccessible (for example, due to a bank failure or liquidity problem), this can trigger a crisis of confidence . Traders might doubt the issuer's ability to meet its obligations, leading to a massive sell-off of stablecoin . This selling pressure would cause their price to plummet below $1.
Impact of massive sales on the price and depreciation of centralized stablecoin
When a crisis of confidence occurs, a massive sell-off of stablecoinby users can quickly overwhelm arbitrage mechanisms. If buyback demand exceeds the issuer's capacity to supply underlying assets, the stablecoin 's price on the secondary market can plummet and depreciate
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Chain reaction : Arbitrage traders, often the first to act, can deplete available reserves by buying back stablecoin at face value. Once these reserves are exhausted, the issuer may no longer be able to fulfill all redemption requests, exacerbating the panic.
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Lasting disconnect : If investors lose confidence in the issuer's reserves or if they feel that liquidity is insufficient, the stablecoin could remain permanently below its parity, or even lose all value, as has been observed with some stablecoin during past crises.
In conclusion, the price of a stablecoin depends heavily on investor confidence in the issuer's reserves and the issuer's ability to guarantee a buyback at $1. This mechanism, while robust, is vulnerable to crises of confidence, reserve freezes, and massive sell-offs, which can lead to temporary or prolonged depegs.
Concrete example:
In March 2023, USDC experienced a depeg following the collapse of Silicon Valley Bank, where $3.3 billion of its reserves were frozen. This link to banking institutions makes these stablecoin vulnerable to traditional financial crises. USDC depeg , users massively sold their tokens, causing a temporary drop to $0.81. Reassuring announcements from Circle and support from the U.S. Federal Reserve helped restore confidence.
What influences the price of a decentralized stablecoin ?
Unlike centralized stablecoin decentralized stablecoin , such as DAI (issued by MakerDAO), do not rely on reserves held by a centralized issuer. They are collateralized by crypto-assets , often more volatile than bank deposits or bonds. This system relies on smart contract contracts , which manage the creation and redemption of stablecoin , as well as an over-collateralization . However, in the event of high volatility, these mechanisms can show their limitations, leading to depeg .
Maintaining anchorage through collateralization
The principle is similar to that of stablecoin , aiming to guarantee an exchange value equivalent to $1. However, in the case of stablecoin , stability is ensured by over-collateralization of the crypto-assets :
stablecoin creation : To issue DAI, for example, a user must lock a quantity of crypto assets (such as ETH or BTC ) in a smart contract . These assets serve as collateral. The value of the deposited assets must generally exceed the value of the issued DAI (for example, by a ratio of 150%) to compensate for the volatility of the collateral.
Redemption and destruction: If a user wishes to recover their collateralized assets, they must repay the exact amount of DAI issued, which is then destroyed. This mechanism helps control the supply of stablecoin in circulation and maintain their peg.
The role of overcollateralization in trust
Overcollateralization plays a similar role here to that of reserves in stablecoin : it ensures that each DAI in circulation is backed by higher-value assets. However, investor confidence relies on the transparency of the protocol and the efficient management of collateral, rather than on the solvency of a centralized issuer.
A concrete example of decentralized depeg:
In March 2023, DAI also fell to $0.91 due to its significant exposure toUSDC. MakerDAO had to adjust its collateral composition to reduce its dependence.
Risks of decentralized stablecoin depeg
However, this model is not without its flaws. If the value of the collateralized assets falls rapidly (for example, during a market crash), the collateral may become insufficient, leading to a risk of depeg. In these situations, the protocol can force the liquidation of the collateralized positions to maintain stability.
Impact of massive sales on the share price
Unlike stablecoin stablecoin depegs are often triggered by significant fluctuations in the crypto-asset market :
Collateral collapse: If the price of collateralized assets falls sharply, the total value of collateral can become less than the value of the stablecoin in circulation. This incentivizes users to sell off their DAI (or other stablecoin ) en masse, amplifying the downward pressure.
Forced liquidations: To avoid a depeg, smart contract can automatically liquidate undercollateralized positions, which adds even more pressure to the market and can accentuate volatility.
Comparison with the depeg of centralized stablecoin
While arbitrage traders also play a role in maintaining the peg of stablecoin , the transparency of the collateral and the autonomy of smart contract make this model less dependent on trust in a centralized entity. However, this autonomy has its limits: if the underlying market collapses or if the liquidation mechanisms are ineffective, a stablecoin can lose its peg, sometimes for extended periods.
In conclusion, decentralized stablecoin volatility of the crypto assets used as collateral . In highly volatile markets, their model can show weaknesses, making them potentially more fragile than stablecoin during periods of significant turbulence.
What influences the price of an algorithmic stablecoin ?
Algorithmic stablecoins differ from stablecoin and decentralized stablecoins in their lack of direct collateral. They rely on stablecoin and smart smart contract to maintain their peg. Their value is not guaranteed by physical reserves or crypto-assets, but by a dynamic system that adjusts supply and demand by issuing or burning tokens. While attractive due to their independence and theoretical scalability, these stablecoin are particularly vulnerable to crises of confidence and volatility, which can quickly lead to a depeg.
Maintaining the anchor through algorithmic mechanisms
The operation of algorithmic stablecoin dual model , where a stablecoin is generally backed by a governance token or a secondary asset. Take, for example, the now-famous UST from Terra, which was backed by the LUNA :
In case of overvaluation (above $1): The algorithm issues more stablecoin into circulation, encouraging users to sell them to bring the price back to parity.
In case of undervaluation (below $1): The algorithm burns stablecoin and issues more secondary tokens (like LUNA), thus reducing the supply to raise the price.
This system relies entirely on user trust in the algorithm's ability to maintain equilibrium. If this trust wavers, the mechanism can collapse , leading to a rapid and severe stablecoin depeg
The critical role of trust
In algorithmic stablecoin bond of trust is even more fragile than in centralized or decentralized models. Since there is no tangible collateral or visible reserves, users must believe that the algorithm will function as intended, even during periods of high volatility. However, this trust is often tested by factors such as:
Turbulent markets: A sharp market downturn can trigger a downward spiral. In the case of UST, the massive buyback demand led to excessive destruction of LUNA, causing its value to plummet and exacerbating the decline.
Speculation: These stablecoin are often used for high-risk strategies, which amplifies their volatility.
Impact of massive sales and depreciation of algorithmic stablecoin
When confidence in an stablecoin collapses, massive selling triggers a chain reaction:
Excessive redemption demand: Users seek to exchange their stablecoin for the secondary token or other asset, putting enormous pressure on the system.
Fall in the value of the secondary token: If demand exceeds the algorithm's capacity, the secondary token loses its value, further reducing the credibility of the stablecoin .
Liquidation spiral: As seen with UST in May 2022, this dynamic can lead to a complete collapse of the stablecoin and the secondary token.
Comparison with the depreciation of centralized and decentralized stablecoin
Unlike centralized or decentralized models, stablecoin have no safety net in the event of a crisis. Neither physical reserves nor crypto collateral can be mobilized to stabilize their value. This makes them particularly vulnerable to depearling spirals , especially during periods of economic stress or intense speculation.
A concrete example of algorithmic depegging:
In May 2022, Terra's UST lost its anchor, leading to a catastrophic fall to less than $0.01. This collapse also caused the bankruptcy of numerous related projects.
Markets in Crypto-Assets ( MiCA regulation imposes strict requirements on stablecoin , including the obligation to maintain a 1:1 liquidity reserve ratio. This means that each stablecoin must be fully backed by an equivalent reserve of assets, held securely and segregated from the issuer's other holdings. This collateralization requirement effectively excludes algorithmic stablecoin , which rely on stabilization mechanisms without traditional reserve assets. Consequently, the issuance of such stablecoin is prohibited under the MiCA .
This ban aims to protect consumers and ensure financial stability by avoiding the risks associated with stabilization mechanisms perceived as riskier and less transparent, characteristic of algorithmic stablecoin.
What lessons for investors?
- Diversify your stablecoin : Don't put all your eggs in one basket, especially during times of uncertainty.
- Seek transparency: Favor stablecoin whose reserves and operation are audited and public.
Conclusion: Risks of depeg
stablecoinare essential to the DeFi ecosystem, but they are not without risk. Their depegs, whether temporary or permanent, highlight the importance of transparency, technological robustness, and risk diversification. It's worth noting that significant depeg events are becoming less frequent as decentralized finance gains traction and regulations are implemented.
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Yoann
Training engineer, I quickly became interested in the field of finance. Convinced that decentralized finance has a bright future ahead of it, I participate in its democratization by developing Crypternon.
