What Happens When a Stablecoin Loses Its Peg?

A stablecoin is designed to stay close to a fixed value, usually $1. But that stability is not automatic. When a stablecoin trades at $0.99, $0.95 or even lower, it has lost its peg. Sometimes the move lasts only minutes. In more serious cases, it signals problems with reserves, liquidity or the mechanism supporting the token. The key question is simple: can holders still reliably redeem the stablecoin for what it claims to be worth? Why Do Stablecoins Depeg? A dollar-backed stablecoin normally remains near $1 because traders expect it can be redeemed for one dollar. If it falls to $0.98 while redemptions still work at $1, traders can buy the token cheaply, redeem it and keep the difference. This arbitrage creates buying pressure that can restore the peg. Depegs become more dangerous when investors doubt the reserves, banks, custodians or redemption process behind the token. The Federal Reserve has warned that stablecoins can face run-like dynamics when many holders try to redeem simultaneously. Situation What typically happens Stablecoin falls slightly below $1 Arbitrageurs buy the discount Redemptions still work Tokens are redeemed for $1 Supply contracts Price tends to move back toward $1 Redemptions become uncertain Holders may rush to sell Reserves are insufficient or inaccessible Depeg can deepen Confidence collapses Recovery may become impossible A Depeg Does Not Always Mean Collapse USDC provided a clear example in March 2023. Circle disclosed that $3.3 billion of USDC reserves were held at Silicon Valley Bank. As uncertainty spread, USDC briefly fell well below $1. Once U.S. authorities protected the bank’s depositors and Circle confirmed access to its reserves, the stablecoin recovered. The episode showed why stablecoin reserves matter: a market-price shock can be temporary if the underlying redemption mechanism remains intact. <iframe src=”https://widgets.coincodex.com/w/d31705c2-3bc9-475f-84d0-7d3ca9c16989?site=coinpaper&mode=light” width=”100%” height=”330” frameborder=”0” referrerpolicy=”no-referrer-when-downgrade” style=”border:0;background:transparent;border-radius:0px;”></iframe>When Does a Depeg Become Dangerous? The real problem begins when buying a stablecoin at $0.80 no longer looks like buying a dollar for 80 cents. If reserves cannot be accessed or sold quickly enough, holders have an incentive to redeem before everyone else. That can create a self-reinforcing run. TerraUSD showed an even more extreme failure. UST did not rely on conventional dollar reserves. Instead, its peg depended on an algorithmic relationship with LUNA. Once confidence disappeared, the mechanism created more LUNA as investors exited UST, accelerating the collapse of both tokens. The Terra depeg demonstrated that not every stablecoin has the same recovery mechanism. What About Trading Above $1? A stablecoin can also depeg upward. If demand pushes a token to $1.02, authorized participants may create tokens at $1 and sell them at the premium. Increasing supply should pull the price back toward the peg.