Crypto: Why do Stablecoins Lose their Peg?

Paigambar Mohan Raj
Source: The Block

Stablecoins have become one of the central players in the crypto industry. Over the years, stablecoins have amassed big coffers, with three of the top five cryptos being stablecoins. So much so that the summer 2022 crash was highlighted by the collapse of the USTC stablecoin from Terra. USTC was an algorithmic stablecoin that lost its dollar peg in early May 2022.

Another algorithmic stablecoin that has lost its peg to the dollar is Tron’s USDD. The crypto stablecoin fell to $0.93 in June of this year. And, since November 27th, the token has not been able to level itself to the dollar.

This year, stablecoins are suffering in general, not just algorithmic ones. One of the most significant cryptocurrency projects, Tether’s USDT, saw some downturns in 2022 and occasionally drifted away from the $1 level. Although stablecoins play an integral part in the cryptocurrency industry, the issues of de-pegging are still prevalent, which begs the question…

Why do crypto stablecoins lose their peg?

The parity of algorithmic stablecoins with the dollar is maintained without collateralized assets and is governed by computer algorithms. They are built to increase or decrease their total circulating supply according to market conditions while preserving their stability.

The main issue is that the algorithm might occasionally be flawed or incorrectly designed. This results in circumstances other than those intended to remove a stablecoin’s parity with the dollar. For instance, in the case of USTC, the Terraform Labs ecosystem had faults that made it possible to take advantage of arbitrage possibilities. Curve (CRV), the crypto that supported the stablecoin’s parity, had a low level of liquidity.

Apart from faulty algorithms, there are other ways a stablecoin can lose its peg.

For instance, Dai, MakerDAO’s stablecoin, has an excellent concept of being decentralized and having its parity guaranteed. However, if Dai does not have a good reserve, it may lose its peg with the dollar during times of market crisis.

On the other hand, centralized stablecoins like USDC and USDT should have a planned reserve for times when the crypto market may encounter mistrust. USDT failed to keep constant throughout the collapse of the Terra ecosystem and FTX. Moreover, the stablecoin’s market sale caused it to lose parity with the dollar.

Tether has often faced backlash for not publishing its reserves and audit reports. The crypto stablecoin’s dominance in the market is consequently diminishing. The firm has made multiple promises to users about its reserves but has not published anything yet. Nonetheless, the firm claimed that it does have the necessary resources.