Stablecoin depegging: The what and why

Considered by some to be the “killer app” of the cryptocurrency space, stablecoin adoption continues to gain momentum. According to a study published in September of 2024:

• The overall supply of stablecoins has grown rapidly since 2017, from under $1 billion to its peak of $192 billion in March 2022.
• Stablecoins settled over $2.6 trillion dollars worth of value in H1 of 2024.
• There are currently over 20 million addresses that make a stablecoin transaction every month. 

But how secure are stablecoins? This article will examine their vulnerabilities, reflecting on the different types of stablecoins, the impact of regulation and the degree to which the issuers are transparent.

A depegging is any event where a stablecoin’s value deviates from the value of its reference asset. This can be either decreasing or increasing in value relative to the asset in question. 

Depeg events in stablecoins are common, with one report identifying 609 instances in 2023 alone.

With that being said, it’s important to consider a few things here:

• No two depeg events are exactly the same. It’s essential to take into account all the contributing factors, such as where the stablecoin is being traded and the relative volume. Stablecoins will often depeg up to 1% either side of the peg for brief periods, lasting from a few minutes to a few days. Major depegs of 10% or more, sustained for more than a day, are far more rare. Even large cap stablecoins sometimes have a sharp drop and immediate recovery. USDC did exactly this earlier this year, dropping to $0.74 on Binance, before quickly returning to $1. 
• Some degree of depegging is to be expected and stablecoins cannot hold their peg at all times. This results in part due the vast number of platforms that stablecoins are used on and the wide range of factors that can challenge the peg. 
• A depegging event does not always reflect badly on the issuer nor does it represent an existential threat to the stablecoin in question. Sometimes, a stablecoin may lose its peg simply because of a lack of liquidity or wider market contagion.

The stability of a stablecoin peg can be influenced by many factors, some of which are beyond the control of its issuer. 

Market volatility can shift supply and demand dynamics, while liquidity differences across platforms might temporarily affect stability. Problems with reserves, such as under-collateralization due to mismanagement or impairment, are also significant risks.

Shifts in supply and demand may push the price above or below the peg, especially when combined with a lack of transparency or loss of confidence. Counterparty performance, which may be affected by financial, operational, legal, or regulatory challenges, adds further complexity.

Technological and design flaws, as seen in the case of TerraUSD, along with vulnerabilities to hacking, pose additional risks. Network issues can cause operational disruptions, and regulatory uncertainty or legal actions may erode trust. 

Lastly, broader financial market events could create a contagion effect, spilling over into the stablecoin ecosystem.

The following is a timeline of some of the largest depegging events to date, focusing primarily on those where a significant depeg occurred over a sustained period.

Tether (USDT), October 2018: Largely as a result of rumours relating to its reserves and withdrawal issues at Bitfinex, Tether depegged 10% to $0.90. This event followed longstanding concerns about Tether’s reserves and controversy over the stablecoin’s impact on the price of Bitcoin (BTC). 

Tether experienced another depegging event in June 2023, owing to an imbalance in the liquidity pool. USDT lost its peg with the US dollar in Curve’s 3pool, a stablecoin pool holding a large amount of liquidity for three stablecoins, USDT, USDC and DAI. 

The balance of the pool should have been 33.33% for each coin, however Tether’s share increased to over 70%, resulting in a depeg to $0.977. Crypto research firm Kaiko indicated that it was “...a possible attempt to depeg Tether” ahead of an important news release. 

The article also highlighted that Tether’s minimum redemption is $100k, meaning that many holders of Tether are obliged to use centralized and decentralized trading platforms.

TerraUSD (UST), May 2022: The infamous meltdown of this algorithmic stablecoin erased over $50 billion in the market capitalization of UST/LUNA and further caused over $400 billion in losses in broader cryptocurrency markets. 

Onchain analytics outfit Nansen conducted a post-mortem into the failure, finding that “...a small number of players identified and arbitraged vulnerabilities - specifically in relation to the shallow liquidity of the Curve pools securing the UST’s peg to the other stablecoins.”

USDC (USDC), Dai (DAI), March 2023: Following an announcement from Circle that $3.3 billion of its reserves were stuck in the failing Silicon Valley Bank, USDC depegged 12% down to $0.88. The incident had a knock-on effect on another crypto-backed stablecoin, DAI. 

As USDC represented over half of the collateral reserves backing DAI, it also suffered a depeg event. Both pegs were restored when the Federal Deposit Insurance Corporation (FDIC) announced a “systemic risk exception”, meaning that it would support the bank's creditors. Tether actually had a favourable depeg during this time to a high of $1.15 as Curve’s 3Pool became heavily imbalanced. 

TrueUSD (TUSD), January 2024: TrueUSD traded down to $0.926 in January of 2024. Some concerns were raised on X (formerly Twitter) about the security of its reserves, marking the beginning of a challenging year for the stablecoin. Binance removed several trading pairs in March and eventually delisted the stablecoin entirely a few months later. 

In September, the SEC announced the settlement of charges with the issuer, “...for their fraudulent and unregistered sales of investment contracts involving TrueUSD (TUSD).”

When a stablecoin loses its peg, the effects can be widespread and damaging. This can lead to significant financial losses, the erosion of trust in the organization behind the stablecoin and create a downward spiral that further impacts its price. 

Some of the most serious consequences of a depegging event include:

• Loss of capital: Perhaps the most obvious impact of a depegging event is the unrealized losses for those holding the coin. Those who are unable to redeem their stablecoins back into fiat are at a disadvantage during a depegging event, and may have to accept the discounted value of their coins if they want to swap out of them. 
• Liquidation of decentralized loans: When USDC depegged in March 2023, this resulted in roughly 3.4k automatic liquidations on Aave’s v2 and v3 markets, derived from $24m of collateral, 86% of which was USDC. During the collapse of Terra UST, the Terra-based lending protocol Anchor saw over $1 billion in liquidations. The depegging of UST created a negative feedback loop: the sister token LUNA was minted in an attempt to restore the peg, which in turn devalued the token. Because many UST loans were collateralized in LUNA, when the price of LUNA plummeted, this in turn resulted in many loans being undercollateralized, leading to inevitable liquidation. 
• Liquidation of margined futures positions: Many crypto-futures contracts are collateralized using large-cap stablecoins such as USDT and USDC. While a stablecoin would need to experience a major depeg to trigger liquidations in margined futures positions, it is possible, particularly for those traders with a relatively thin liquidation buffer at the time the depeg occurs. 
• Loss of trust and damage to reputation: Stablecoins that frequently depeg or experience a major depegging are likely to suffer reputational damage, while also possibly inviting regulatory scrutiny. 
• Contagion: The failure or perceived failure of a stablecoin can also create a spillover effect, influencing the wider cryptocurrency market, investor attention and market sentiment.

Maintaining the stability of the peg in a volatile and highly fluid environment is one of the major challenges that every issuer faces. Stablecoin issuers mitigate the risk of a depegging in a few ways:

1. By managing the circulating supply of a coin through minting and redemptions. This ensures that there aren't more coins in circulation than there should be, which could jeopardize the peg.
2. By working closely with regulators to ensure the company’s activities comply with local laws, including anti-money laundering legislation and international sanctions. 
3. By publishing regular, transparent and detailed attestations of the real-world assets backing any stablecoin, by a reputable third party. 
4. By making sure that there’s always enough reserves to honor any redemption, particularly at times when a major news event causes a spike in demand. 

For a more detailed look, check out our Kraken Learn Center guide, How secure are stablecoins

The answer to this question really comes down to holistically researching any stablecoin so you can assess the risk. 

First, examine previous depegging events, look at how frequently they occur, their severity and how quickly the peg was restored. Look at the causes for the depegging - was it the result of mismanagement by the issuer or by the developers? What lessons were learned and what measures were subsequently put in place to ensure the same event does not occur again?

Second, scrutinize the issuers behaviour with respect to transparency and regulators. It should be very easy for any potential investor to investigate and see how a stablecoin is collateralized. If an issuer generates attestations on their reserves, are they published frequently enough to inspire confidence? Are they fully transparent and accessible to a lay person? Who is conducting the audits? Are they a reliable third party and qualified to do the job?

Look at how a company has responded to challenges by regulators for transparency or when they have fallen foul of the law. 

Finally, look at the technological infrastructure that a stablecoin operates on. If it’s a crypto-backed or algorithmic stablecoin, are the smart contracts audited by an independent auditor? Has anyone raised any concerns about any potential design flaws that could lead to an exploit? 

If a smart contract was exploited in the past, what was the outcome and how did the developers respond? Stablecoins can only function properly if the blockchain they reside on can reliably process transactions. If a blockchain has an extended period of outage, this has potentially serious ramifications. Are there any cases where a blockchain has failed and what was the impact on holders of the stablecoin? Did it affect the peg in any way?

Something else to consider is spreading your capital across two or more stablecoins, which may serve to mitigate the overall risk of depeg.

There are two primary ways to purchase stablecoins.

1. If you are looking for a fiat-backed stablecoin, you may be able to go directly to an issuer and have your fiat US Dollars or Euros converted into stablecoins. Whether you will be able to do this will depend on several factors, including where you are located, whether you have a bank account and whether you can provide appropriate documentation. Large entities looking to convert large amounts of fiat into a stablecoin without the risk of slippage or user error may find this option suitable.
2. The other more straightforward way to acquire stablecoins is to exchange assets you hold at a centralized or decentralized trading platform. At Kraken for example, you can deposit fiat currency and then use one of several stablecoin markets to convert it. If you are looking to convert other crypto assets into a stablecoin, this can be easily achieved by using decentralized platforms such as Uniswap or Sushi, which (at press time) have lots of liquidity. 

For more information, check out our Kraken Learn Center article, Web3 wallets: A complete guide

Anyone seeking to use stablecoins has to accept that depegging events are, in many cases, an inherent and unavoidable flaw. 

While depegs are common, they vary wildly in nature, as all stablecoins are simply unable to be perfectly pegged to their reference asset 100% of the time. 

With that being said, a major depegging event is not necessarily fatal and history tells us many coins have experienced a depeg of 10% or more and recovered. 

Investors looking to deploy capital into stablecoins should think critically about the merits of each coin, its history and the measures in place to mitigate depegging.

If history is anything to go by, stablecoins will continue to play an important role in the space, with the large-caps generally maintaining a stable value in an acceptable range either side of the 1:1 peg.

Now that you have a better understanding of stablecoin depegging, why not explore stablecoins and the wider crypto ecosystem on Kraken?

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