What is stablecoin depeg and why does it matter?

"Stablecoin depeg" has been gaining traction over the past year due to the extensive usage of the digital asset by millions across the globe.

Despite the negative effects of what became known as crypto winter due to the plunge in the worth of the decentralized finance market, stablecoins executed around $7 trillion worth of transactions in 2022.

What's impressive is that last year's value was a 23% rise from 2021, when the stable assets executed approximately $6 trillion worth of transactions.

Trailing only Visa, the stable asset class outpaced other payment processing companies such as Discover, Mastercard, and American Express during one of the worst periods in the trading history of virtual currencies. 

With the world of work changing, which has forced the hands of many employers worldwide to offer some employees’ salaries in crypto due to its relatively lower fees, it has become an instrumental part of the lives of several remote workers. 

This is why stablecoin depeg has risen above many terms in the crypto sector and has become a subject you should not take lightly. 

Stablecoin depeg: Where does it begin?

To understand this, you should first know what a stablecoin is. 

Its meaning can be directly derived from its name, a coin that is stable. According to Investopedia, it is a part of the crypto family and values are tied or pegged to commodities, financial instruments, or fiat currencies like the US dollar (USD), Euro (EUR), or the Great British pound (GBP). 

Satoshi Nakamoto introduced blockchain technology-backed financial currencies to compete directly with centralized finance-backed currencies. Therefore, we would be focusing on crypto paired with fiat currencies as a measure for explaining depegging.

Most stablecoins are pegged 1:1 with fiat currencies, so depegging occurs when their values deviate substantially from their pegged rate.

This unfortunate situation normally occurs on the back of regulatory changes, liquidity issues, and market conditions depending on the type of stablecoin. 

What are the types of stablecoins? 

They come in three types: coins backed by fiat currency as earlier explained, others backed by commodities such as gold and silver, and those backed algorithmically by smart contracts.

Among others, the most popular are Tether Limited’s United States Dollar Tether (USDT), Circle’s United States Dollar Coin (USDC), Binance’s USD (BUSD), DAI, USDP, Euro Coin (EUROC), and TerraUSD (UST). 

While stablecoin issued by Circle and Tether is directly supported by USD and EUR, UST was an algorithmic stablecoin by Terraform Labs, a project that collapsed in May 2022. 

UST de-pegged due to its linkage to LUNA, the native asset behind the Terra ecosystem – a project that once surpassed $20 billion in total value locked (TVL). 

Due to its reliance on LUNA, once traders lost interest in Terra’s flagship cryptocurrency, UST could not be redeemed against its parent virtual currency. This led to mass selling and plunged the coin into irrecoverable zones. 

In March 2023, USDC briefly depegged from the USD in large part due to Silicon Valley Bank, a now-defunct financial institution in the US where around $3 billion of the stablecoin's reserves were held.

In 2018, USDT, which remains the largest stablecoin by market capitalization with approximately $83 billion in value, briefly depegged.

Should you be concerned about another major stablecoin depeg? 

Yes, you should be extremely concerned, considering the collapse of UST began crypto winter that wiped more than $1 trillion off the crypto economy in 2022. 

Understand that the DeFi sector is highly volatile, and several agencies continue to plan to introduce some regulation to the market, which could impact the asset class negatively.

Aside from that, issuers can fail holders of a particular coin, while large selling by traders who want to cash out their assets can also affect their stable value.