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The Depegging of Stablecoins: Why It Happens

The Depegging of Stablecoins: Why It Happens

By SimpleSwap | SimpleSwap Blog | 22 Apr 2024


Stablecoins are like a safe harbor in the volatile Crypto World. Essentially, they're digital assets whose value is tied to a relatively stable financial instrument such as fiat currency, gold, etc. This connection makes them convenient to use and beneficial for users, but unfortunately, they're not “bulletproof”.

When the value of a stablecoin for some reason stops being tied to the value of the asset it's pegged to, it's called depegging. Let's delve into this phenomenon in more detail.

Stability in the Crypto Space

The need for stablecoins arises from their ability to maintain a constant price over a prolonged period. This provides a foundation for traders and investors, allowing them to experiment safely in the cryptocurrency arena.

Today's crypto market is extremely volatile and, in some sense, unreliable compared to traditional financial markets. Here, what was worth millions yesterday can lose its value within hours due to what's known as a "market panic," fueled by the inherently volatile nature of assets.

Depegging of Stablecoins Explained

Depegging occurs when the value of a stable cryptocurrency falls below its pegged value. This leads to:

  • Loss of market participants' price reference points.
  • Inefficiency of basic transactions.
  • Inability to make long-term plans.
  • Market grows.

Why Does Depegging Happen?

Stablecoins maintain stability by keeping liquidity levels steady. They can be backed by any assets currently supported in the market.

Depegging occurs when there are disruptions in the mechanism ensuring the stability of stablecoins. These disruptions can be controlled or uncontrolled. In the former case, assets are deliberately withdrawn from exchanges, with users being notified in advance. In the latter case, it's a "feverish volatility."

Main causes of stablecoin depegging:

  •  Legal issues;
  • Audit problems;
  • Lack of transparency in reserve reports;
  • Difficulties in assessing collateral asset values;
  • Vulnerabilities of smart contracts ensuring asset price stability;
  • Influence of external global factors and events.

Depegging causes can be divided into conditional subgroups:

  • Regulatory

Factors stemming from the activities of governments and their regulatory bodies. Stablecoin depegging may occur due to changes in legislation, the development of new control rules for decentralized exchange activities, and innovations in law enforcement practices.

  • Administrative

Mistakes related to management activities, incompetence of top managers, and errors in compiling asset portfolios may lead to failures and disruptions in the functioning of the system.

  • Technical

Failures and glitches can occur not only due to human factors (as in the previous point) but also due to imperfections in pre-established technical models. Technical insolvency of liquidity support protocols will lead to forced stablecoin depegging. Also, techno-economic reasons may include external economic crises and violations of partnership agreements.

Prominent Examples of Stablecoin Depegging

Stablecoin depegging is a negative event but not fatal. Like any crisis, it often serves as a good test for exchanges and companies. For users, it's an additional opportunity to test the resilience of their crypto wallets and develop crisis management strategies.

There are several notable examples of stablecoin depegging in crypto history.

  • TerraUSD (USTC) was launched in 2020 during the global COVID crisis. Two years later, depegging occurred, symbolizing the beginning of a protracted "crypto winter." 
  • Binance USD (BUSD), a stablecoin launched in 2019 on the Binance platform, was gaining momentum by 2022, entering the top 3 most popular stablecoins and instilling confidence in users for further operation. In February 2023, the company announced the cessation of BUSD issuance due to a major SEC investigation involving Binance, Coinbase, and several other companies. All the advantages of the stablecoin turned into structural vulnerability, leading to controlled depegging and devaluation thereafter.

Conclusion 

In conclusion, it's worth emphasizing once again that long-term play in the cryptocurrency field is impossible without stablecoins. They provide users with confidence in the future and create a sense of reliability and security in the market. Depegging can occur due to various reasons, influenced by government decisions, technical glitches, or management errors. Therefore, it's not advisable to rely entirely on a single stable asset and build a trading strategy around it. As practice shows, even the most reliable stablecoins can be devalued over time.

If you want to learn more interesting facts about crypto then check out our blog! You might like our articles “What Are Vested Tokens? ” and “Immersion Cooling: Liquid as a Medium”.

The easiest way to buy, sell or exchange coins is to use SimpleSwap services.
SimpleSwap reminds you that this article is provided for informational purposes only and does not provide investment advice. All purchases and cryptocurrency investments are your own responsibility.

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