The implosion and Depegging of Stablecoins such as UST has become an issues that should trigger discussion.
Reading Bankless article this week, they explained that a Stablecoin depeg when the price of Stablecoin is below the striking price.
Here are some factors i think could cause a depegging of Stablecoins.
Business Model Factor:
I learned the major reason for the depegging of Stablecoin is due to lack of workable business model. For instance, UST is an algorithmic Stablecoin whose system does not work properly.
Lack of transparency in business:
One of things that could cause depegging is lack of transparency. This is because investors who hold Stablecoin will be forced to dump on the news of lack of business transparency.
When government issue a regulation that is unfavorable it’ll diminish investors’ confidence on Stablecoin.
Here are the interesting questions for discussion.
Asides from the above factors that could cause a depeg of Stablecoins, what other factors could cause depegging of Stablecoin?
What can be done to prevent a depegging of Stablecoins?
Mismatched Reserves: An asset-backed stablecoin will lose the peg when the issuing entity fails to back tokens 1:1 with the underlying asset. However, for this to materialize, markets must be aware of the mismatch. Stablecoin giants like Tether do not generally provide this information to the public in a transparent manner because it conflicts with their own interests.
Markets Outperform The Algorithm: Smart contracts can secure an asset’s currency peg through supply and demand, but only to an extent. When the market outperforms the algorithm or crashes too quickly, the currency starts losing its peg, which can quickly lead into a death spiral. This was the case with the Terra UST stablecoin.
How Do You Prevent Stablecoin Depegging Events?
Regulation: Though cryptocurrencies are generally seen as anti-government and anti-establishment, sound regulation and compliance measures are needed to ensure assets are backed by adequate reserves. In its absence, money is created out of thin air.
Arbitrage: Strong arbitrage mechanisms can help algorithmic stablecoins add a layer of protection atop smart contract management. Whenever a stablecoin trades under a dollar, arbitrageurs can purchase it for cheap, later exchanging it for $1, bagging a profit, and restoring the peg.
There are several actions that can be taken to help prevent a depegging of stable coins, which are Crypto currencies that are designed to maintain a stable value relative to some external reference.
Here are some examples:
✓ Maintain an appropriate level of reserves:
One way to guarantee the stability of a stablecoin is to hold sufficient reserves of the asset or currency that the stable coins is pegged to. For instance, if a stablecoin is pegged to the US dollar, the issuer should hold a sufficient amount of US dollars in reserve to cover the outstanding stablecoins in circulation.
✓ Implement appropriate risk management measures:
It is important for stable coin issuers to have strong risk management processes in place to mitigate risks of market flunctuations and other factors that could cause the value of the stable coins to divert from it’s peg. This may include measures such as diversifying the types of assets held in reserve or using financial instruments such as futures contracts to hedge against potential price movements.
✓ Foster trust and transparency:
Building trust and transparency with users is essential for the stability of any stable coin. Issuers should be transparent about their operations, including the size of their reserves and the methods they use to maintain the peg. They should also have strong security measures in place to protect against external threats such as hacking or fraud.
✓ Ensure regulatory compliance:
Stable coins that are issued by regulated entities are more likely to be trusted by users, as regulatory oversight can provide an additional level of assurance that the issuer bis acting in the best interests of it’s users. It is important for stable coin issuers to ensure that they are operating in compliance with all relevant laws and regulations.
There are several factors that can cause a stablecoin to depeg from its intended peg, such as market demand, market manipulation, and issuer mismanagement.
Market demand: If there is a high demand for a stablecoin, it could lead to an increase in the price of the stablecoin above its intended peg. This can happen if people are buying the stablecoin as a speculative investment, rather than using it as a means of storing value.
Market manipulation: Some market participants may try to manipulate the price of a stablecoin by buying or selling large amounts in order to move the price in a certain direction. This can lead to the stablecoin depegging from its intended peg.
Issuer mismanagement: If the issuer of a stablecoin is not able to properly manage the supply and demand for the stablecoin, it could lead to the stablecoin depegging from its intended peg. This could be due to poor risk management practices, insufficient reserves, or other issues.
Overall, it is important for stablecoin issuers to carefully manage their stablecoins and maintain their pegs in order to ensure their stability and credibility.
There are lots of factor’s that can cause stable coin to become depegged from it assets or 1. currency. These factors includes
Loss of trust: if there is a loss of trust in the stable coin or organization that issues it, it can lead to a decrease in demand for the coin and cause it to become depegged.
2.macroeconomic events: macroeconomic events, such as recession or currency crisis, can cause the value of the target asset or currency to fluctuate, leading to depegged of stable coin.
Limited liquidity: if a stable coin has limited liquidity, it can make more difficult for the issuer to maintain the peg, especially during time of high demand or volatility. This can lead to depegged.
There are several measures that can be taken to prevent a stable coin from becoming depegged from it target Price. Some of the measures include.
Several measures can be taken to help prevent the depegging of stablecoins, which are cryptocurrencies that are designed to maintain a stable value relative to a specific asset or basket of assets. Some strategies that have been proposed or implemented by stablecoin issuers include:
Maintaining sufficient reserves: Stablecoin issuers can hold reserves of the underlying asset(s) that the stablecoin is pegged to maintain the peg. For example, if a stablecoin is pegged to the US dollar, the issuer can hold a reserve of US dollars to help ensure that the stablecoin remains pegged to the dollar.
Using collateralized stablecoins: Collateralized stablecoins are backed by a reserve of assets that is greater than the value of the stablecoin in circulation. This helps to reduce the risk of the stablecoin depegging due to a sudden drop in demand for the stablecoin.
Implementing algorithmic stabilization: Some stablecoins use algorithms to automatically buy or sell the stablecoin to maintain the peg. This can help to stabilize the value of the stablecoin even if there is a sudden shift in demand.
As its name implies, it is stable since it doesn’t experience the same kind of volatility as when crypto assets reset.
Because it is UST, it is always linked to the US dollar and is hence attached to it.
There are several ways for stablecoins to maintain their pegs. They might be supported by other resources like fiat money, other cryptocurrencies, or commodities like gold, oil, or real estate. For instance, the most popular stablecoin, USD Coin, is backed by the dollar. Through cryptocurrency exchanges, you can exchange $1 for 1 USD Coin, which is then created for you while the dollar is kept in storage. If you later traded it back, you would receive a dollar back while the USD Coin is destroyed.
Together with Luna, a sister cryptocurrency token that is also based on the Terra blockchain, Terra USD (UST) manages to strike the right balance. Investors can always trade 1 UST for $1 worth of Luna; doing so results in the creation of a new Luna coin and the burning of the UST. Alternatively, if $1 of Luna is traded for 1 UST, the new UST is created and the exchanged Luna is destroyed.
Thus, a system of forces is created. Investors have the chance to profit from arbitrage if UST drops below $1 by exchanging their less-than-dollar-worth of UST for dollars worth of Luna.
But its problems might have far worse immediate repercussions for the rest of the bitcoin market. The market has been overrun with Luna, whose price has fallen and caused a significant sell-off, as UST struggles to reclaim its peg. Additionally, worries are rising that Terra may have to sell some of its Bitcoin in order to maintain its peg.
Good work here @Progrezz
I think Stablecoins depegging can also be caused by "FEAR" in the sense that when the market grow much fear on a particular Stablecoin, it depegs.
This kind of wild fear😱 may cause so much selling pressure in the market, in the worst case, triggering heavy withdrawal of that particular Stablecoin to fiat currency.
@Progrezz nice work once more…
I have a question though.
Apart from these Factors that could cause a depegging of stable coins:
*Business model factor
*Lack transparency in business
What other factors could also lead to the depegging of these stable coins?.
Thanks for this reply. I actually saw this before and was abit confused so i thought i should drop this,and i will definitely note corrections so i don’t miss this up. I recently learned that collateralized stablecoins make use of crypto assets via an electronic vault system that triggers a smart contract to mint brand new stablecoins. And due to crypto’s inherent volatility, assets are often overcollateralized, with ratios routinely reaching 200%. which in turn leads to highly decentralized yet capital-inefficient stablecoins. A cryptographically collateralized stablecoin gives up capital efficiency to maintain decentralization. As the crypto market matures and volatility decreases, it is likely the collateralization ratios will fall, which means this measure simply can’t help prevent stablecoins from depegging. Also, algorithmic stablecoins rely on an algorithm that pegs itself to a physical currency. They are not fully backed by collateral and rely on an algorithm to maintain their 1:1 price peg.
Due to its undercollateralized nature, this stablecoin is both decentralized and capital-efficient. The weakness of these stablecoins is a lack of stability. which is a highly desired feature of stablecoins, and it has proven an elusive goal for all algorithmic stablecoins to date. Recently, the algorithmic stablecoin TerraUSD (UST) lost its peg. This depegging caused a quick collapse that severely impacted the entire crypto market.
For now, I don’t think a suitable measure is known; hopefully, more innovations towards the crypto landscape will come through.
So, with all these observations, do the listed measures remain effective?
Or Does it mean the measures are effective but temporary?
The effectiveness of the measures to prevent a depegging of stablecoins can vary depending on the specific implementation and the overall market conditions.
Some of these measures, such as maintaining sufficient reserves or using collateralized stablecoins, can be effective in preventing a depegging in the short term by providing a buffer against sudden changes in demand for the stablecoin. However, these measures alone may not be sufficient to prevent a depegging in the long term, especially in the case of a prolonged market downturn or economic crisis.
Other measures, such as implementing algorithmic stabilization, can help to stabilize the value of the stablecoin in the short term by automatically buying or selling the stablecoin to maintain the peg. However, these algorithms may not be able to keep up with a rapid change in market conditions, and their effectiveness may depend on the specific algorithm and its parameters.
Overall, while these measures can help to prevent a depegging of stablecoins, they are not guaranteed to be effective in all cases and may require ongoing monitoring and adjustments. Additionally, Stablecoins also need to comply with regulatory requirements and have robust risk management.
Interesting comment here, the markets outperform the algorithm - if this were true, the solution might be to improve the algorithm. But I don’t think the blame lies there, but in the algorithmic peg mechanims’ ability to maintain liquid function. The algorithm underperformed relative to the size of the market movement? The initial blow to terra’s peg was too large & fast for recovery, before depeg fear caused greater fear & flight from UST & Luna? So the algo need work faster?