Depeg Event

What Is a Depeg Event?

A depeg event is when a stablecoin's market price diverges meaningfully from its intended peg, typically $1 for USD-denominated stablecoins. Small fluctuations of a fraction of a cent are normal and expected. A depeg refers to larger, sustained deviations that signal something has gone wrong with the mechanism holding the price stable.

Depegs range in severity from minor (a few percent, lasting hours) to catastrophic (complete collapse to near zero). The cause, duration, and depth of a depeg depend on the stablecoin's design, the quality of its reserves, and how the market responds to stress. Some depegs are temporary dislocations caused by external shocks; others reveal fatal flaws in the underlying peg mechanism.

Understanding depeg events is critical for anyone holding or building on stablecoins. A stablecoin that depegs can wipe out savings, trigger cascading liquidations across DeFi protocols, and undermine trust in the broader stablecoin ecosystem. The history of crypto is filled with depeg events, and each one has reshaped how the industry thinks about stablecoin design.

How Depegs Happen

Depeg events are rarely caused by a single factor. They typically involve a trigger event that exposes an existing vulnerability, followed by market dynamics that amplify the initial shock. The most common causes fall into four categories.

Reserve Concerns

The most fundamental cause of a depeg is doubt about whether the stablecoin is actually backed by what the issuer claims. If a fiat-backed stablecoin advertises 1:1 dollar reserves but the market suspects otherwise, holders rush to redeem before reserves run out. This creates selling pressure that pushes the price below the peg.

Reserve concerns can stem from many sources: opaque audits, regulatory actions against the issuer, exposure to failing banks or risky assets, or simply rumors. The key insight is that stablecoins run on confidence. Even fully backed stablecoins can depeg temporarily if enough holders doubt the backing simultaneously.

Liquidity Crises

Even a well-collateralized stablecoin can depeg if there isn't enough market liquidity to absorb selling pressure. If large holders try to exit simultaneously and the available buy-side liquidity on exchanges and DEXs is thin, the price drops mechanically. This is particularly dangerous during broader market panics when liquidity dries up across all assets.

Redemption bottlenecks worsen liquidity crises. If a stablecoin issuer processes redemptions with a delay (common for fiat-backed coins requiring bank transfers), holders who can't wait sell on the open market at a discount, pushing the price further below the peg.

Oracle Failures

Many stablecoins, particularly algorithmic and overcollateralized designs, rely on price oracles to feed market data into smart contracts. If an oracle reports incorrect prices or stops updating, the peg mechanism can malfunction. An oracle manipulation attack can deliberately trigger a depeg by feeding false price data that causes the protocol to mint or burn tokens incorrectly.

Bank Run Dynamics

Stablecoins are susceptible to the same bank run dynamics that affect traditional financial institutions. When holders believe others will redeem first, rational self-interest drives everyone to redeem simultaneously. This creates a self-fulfilling prophecy: the rush to exit causes the very collapse that holders feared.

For algorithmic stablecoins, bank runs are particularly devastating because redemptions themselves can destabilize the peg mechanism. Each redemption puts downward pressure on the collateral token, reducing the protocol's ability to defend the peg, which triggers more redemptions: the classic death spiral.

Historical Depeg Events

UST Collapse: May 2022

The collapse of TerraUSD (UST) remains the most catastrophic depeg event in crypto history. UST was an algorithmic stablecoin that maintained its peg through a mint-and-burn mechanism with the LUNA token. When large withdrawals from the Anchor protocol (which offered ~20% yield on UST deposits) triggered selling pressure, UST slipped below $1.

The death spiral dynamics were textbook: as UST depegged, holders redeemed UST for LUNA, which flooded the market with LUNA tokens. LUNA's price collapsed, reducing the backing for UST further, which caused more redemptions. Within five days, UST fell from $1 to under $0.10, and LUNA went from $80 to effectively zero. Over $40 billion in combined market value was destroyed.

The UST collapse demonstrated that algorithmic peg mechanisms without adequate exogenous collateral are inherently fragile. The "reflexivity" problem: using an endogenous token (LUNA) to back a stablecoin (UST) creates a circular dependency that unravels under stress. For a detailed breakdown of these failure dynamics, see death spiral.

USDC and Silicon Valley Bank: March 2023

In March 2023, Circle disclosed that $3.3 billion of USDC's reserves (roughly 8% of the total) were held at Silicon Valley Bank, which had just failed. Over a weekend when banks were closed and redemptions were impossible, USDC traded as low as $0.87 on secondary markets.

This depeg was fundamentally different from UST's. USDC's reserves were real and diversified: the vast majority was in short-term Treasuries and other stable assets. The SVB exposure represented a fraction of total backing. Once the FDIC announced that all SVB deposits would be protected, confidence returned and USDC re-pegged within days.

The USDC depeg illustrated that even fully backed stablecoins carry counterparty risk through their banking relationships. It also demonstrated the resilience of fiat-backed models: when reserves are genuinely intact, the peg can recover.

USDT Wobbles

Tether (USDT) has experienced several minor depeg episodes throughout its history, typically triggered by concerns about reserve transparency. In October 2018, USDT briefly traded at $0.85 amid doubts about Tether's banking relationships. In May 2022, following the UST collapse, USDT dipped to $0.95 as contagion fears spread across all stablecoins.

USDT has recovered from each depeg, largely because Tether has consistently honored redemptions at par. The ability to redeem at $1 directly with the issuer creates an arbitrage floor: traders buy discounted USDT on the open market and redeem with Tether for a profit, which pushes the price back toward the peg.

The Feedback Loop: How Depegs Worsen

Depeg events rarely stabilize on their own. Several feedback loops can accelerate a small deviation into a crisis:

1. Panic selling: as the price drops, holders sell to cut losses, adding more downward pressure
2. DeFi liquidations: stablecoins used as collateral in lending protocols get liquidated as their value drops, creating forced selling. These liquidation cascades can amplify a depeg across multiple protocols simultaneously
3. Liquidity pool imbalance: automated market makers become heavily skewed toward the depegging token as arbitrageurs drain the paired asset, worsening slippage for remaining sellers
4. Contagion: a depeg in one stablecoin triggers fear in others, especially those with similar designs or shared infrastructure. The UST collapse caused temporary depegs across multiple unrelated stablecoins
5. Redemption queues: if direct redemption with the issuer becomes backlogged, market participants lose confidence in the arbitrage mechanism, and the discount deepens

The speed of these feedback loops depends on the stablecoin's design. Algorithmic stablecoins with on-chain redemption can spiral in hours. Fiat-backed stablecoins with off-chain redemption may take days to resolve, but the off-chain reserves act as an anchor that limits how far the depeg can go.

How Different Stablecoin Types Respond to Stress

The critical factor is whether a stablecoin's backing is exogenous (external assets like dollars, Treasuries, ETH) or endogenous (the protocol's own token). Exogenous backing provides a real floor for the price. Endogenous backing creates circular dependencies that can unravel. For a deeper comparison, see the USDB stablecoin deep dive.

Recovery Mechanisms

Not all depegs are permanent. Several mechanisms can restore the peg after a disruption:

• Arbitrage: when a stablecoin trades below $1 but is redeemable at $1 from the issuer, arbitrageurs buy the discount and redeem at par. This is the primary recovery mechanism for fiat-backed stablecoins and requires functioning redemption infrastructure
• Protocol intervention: overcollateralized stablecoins can adjust parameters (stability fees, liquidation ratios, collateral types) to restore equilibrium. Emergency governance votes can authorize extraordinary measures
• External backstops: some stablecoin issuers maintain reserve funds or insurance mechanisms specifically for defending the peg during stress events. Traditional finance regulators can also intervene, as the FDIC did during the SVB crisis
• Market confidence restoration: sometimes the depeg resolves when the underlying fear is addressed. Transparent communication from issuers, proof-of-reserves disclosures, or resolution of the triggering event can restore confidence without any mechanical intervention

Monitoring for Depeg Risk

On-chain data and market signals can provide early warning of depeg events. The following pseudocode illustrates a basic monitoring approach:

// Simple depeg monitoring logic
function checkDepegRisk(stablecoin) {
  const marketPrice = getOraclePrice(stablecoin);
  const targetPeg = 1.00;
  const deviation = Math.abs(marketPrice - targetPeg) / targetPeg;

  // Tier 1: Minor deviation (normal volatility)
  if (deviation < 0.005) return "HEALTHY";

  // Tier 2: Notable deviation (watch closely)
  if (deviation < 0.02) return "WARNING";

  // Tier 3: Significant depeg (consider action)
  if (deviation < 0.05) return "DEPEG_ALERT";

  // Tier 4: Severe depeg (emergency)
  return "CRITICAL";
}

// Additional signals to monitor:
// - Redemption queue depth and processing time
// - DEX liquidity pool ratios (imbalance > 80/20 is a red flag)
// - Large holder movements (whale exits)
// - Issuer reserve composition changes

Real-world monitoring combines price feeds from multiple sources, on-chain liquidity metrics, social sentiment analysis, and issuer transparency reports. Automated alerts on these signals can give holders and protocols time to react before a depeg deepens.

User Protection Strategies

While no strategy eliminates depeg risk entirely, several practices reduce exposure:

• Diversify across stablecoin types: holding a mix of fiat-backed, overcollateralized, and yield-bearing stablecoins means a depeg in one doesn't wipe out your entire position
• Understand the backing: read reserve attestations and understand what assets actually back each stablecoin you hold. Transparent, high-quality reserves (short-term Treasuries, cash) are safer than opaque or exotic backing
• Monitor issuer health: track the issuer's banking relationships, regulatory standing, and reserve disclosures. Changes in any of these can be early depeg signals
• Avoid concentrated DeFi positions: using a single stablecoin as collateral across multiple lending protocols creates correlated risk. A depeg triggers liquidations everywhere simultaneously
• Maintain direct redemption access: for larger holdings, having a verified account with the stablecoin issuer allows you to redeem at par rather than selling at a market discount during a depeg
• Set automated exit triggers: configuring alerts or automated trades at specific price thresholds lets you respond to depegs faster than manual monitoring allows

Risks and Considerations

Depeg events expose several systemic risks in the stablecoin ecosystem that are worth understanding even outside of any specific event:

• Contagion across DeFi: stablecoins are the most widely used collateral type in DeFi lending. A major depeg can trigger liquidation cascades across protocols, amplifying losses far beyond the stablecoin itself
• Regulatory response: major depeg events accelerate regulatory scrutiny. The UST collapse directly influenced stablecoin regulation frameworks including specified stablecoin designations and e-money token requirements in various jurisdictions
• Precision decay in secondary markets: during a depeg, price feeds and automated systems may struggle with unusual price levels, causing further inaccuracies in DeFi protocol behavior
• Trust erosion: even temporary depegs damage long-term confidence. Users who experience a depeg may permanently shift to alternative stablecoins or exit the ecosystem entirely, reducing the stablecoin's liquidity and making future depegs more likely
• Recovery asymmetry: depegs happen fast but recoveries are slow. Confidence can evaporate in hours but takes weeks or months to rebuild, during which the stablecoin trades at a persistent discount

This glossary entry is for informational purposes only and does not constitute financial or investment advice. Always do your own research before using any protocol or technology.