A depeg occurs when a stablecoin loses its intended fixed value (typically $1) and trades at a different price.
Other pegged assets such as wrapped tokens are designed to follow the value of another crypto asset that exists on a different blockchain network. They are a useful workaround for some of the limitations blockchain networks have in terms of interoperability.
In some scenarios these assets might fail to achieve their purpose, however. They might arrive at a value that varies from the expected value by a non-trivial margin. In all cases, a situation where a pegged asset strays from its expected value is known as a “depeg.”
Different factors can come into play in these scenarios such as unexpected market forces, failures in their implementation, and sometimes poor design. Some of the most common ones include:
Liquidity Issues: If there isn’t enough liquidity in markets or redemption mechanisms fail, the asset can lose its peg.
Panic Selling or Bank Runs: Holders rushing to exit a stablecoin or wrapped asset can trigger depegging.
Smart Contract Vulnerabilities: Bugs or exploits in the code can break price-pegging mechanisms.
Regulatory Risks: Government crackdowns or restrictions on fiat-backed stablecoins can impact pegs.
Market Manipulation: Large entities or “whales” can deliberately short or dump an asset to cause a depeg.
Crypto markets have seen multiple depeg situations in the past. The most notable of these was the infamous TerraUSD (UST) depeg. In May 2022, the value of the third-largest stablecoin in crypto markets fell dramatically below the value of the asset it was designed to imitate, the US dollar.
The UST fallout became a prime example of a depeg situation. Over $60 billion dollars in market value was lost in the middle of a “death spiral” where an initial depeg produced a market panic that led to a complete loss of the crypto asset’s value with respect to USD.
Depegs can be very impactful due to their wide influence in crypto markets. Stablecoins and other pegged assets are often used as collateral for other crypto operations. Therefore, a depeg event can have catastrophic consequences for lending markets, decentralized exchanges, and other associated web3 applications. This is why depegs are often considered a system risk.
Not all depegs are catastrophic, however. In some situations, depegs can be due to momentary fluctuations in the market or foreseeable behaviors in their underlying implementation that are resolved swiftly. Some of the leading stablecoins in the market such as USDC have momentarily depegged to $0.74 on the dollar in the past without falling into a “death spiral.”
Examples include pegged assets based on off-chain fiat collateralization, commodity collateralization, or even collateralization with other crypto assets. In the case of UST, the asset became a failed experiment in the use of algorithmic collateralization to maintain a pegged value with the US dollar.
Currently, there are alternative approaches to depeg situations where they are reframed as a natural component of crypto markets. An example can be seen with the introduction of Depeg Swaps.
Depeg Swaps are a new financial instrument in web3 that tokenizes the risk of depeg situations, protecting users and DeFi protocols from the risk of onchain assets losing their expected market value. They effectively allow market participants to price and trade a specific onchain assets’ risk for a depeg. These assets can also be used in other DeFi applications as a new financial instrument for hedging or speculation.
Authored by Phil Fogel
Phil Fogel, Co-Founder of Cork, has a unique background that bridges traditional finance and cutting-edge blockchain technology. His career began in options trading before he pivoted into fintech and asset management. In the early 2010s, after being introduced to Bitcoin by a family connection, Phil immersed himself in the world of crypto, initially exploring arbitrage opportunities across exchanges. His deeper dive into Ethereum in 2017 led him to explore the potential of DeFi, smart contracts, and blockchain’s ability to reshape financial systems. Phil’s hands-on approach—ranging from mining Litecoin to working on blockchain-based staking infrastructure—has given him a comprehensive understanding of the space.
Phil’s journey further evolved with Flow Carbon, a company he co-founded to bring carbon credit markets on-chain. Today, as Co-Founder of Cork, a DeFi primitive built on Ethereum and accelerated by a16z Crypto, Phil is focused on creating innovative solutions to price, hedge, and trade risk. Cork has introduced a novel approach to protect crypto users against depeg events for stablecoins, liquid staking, RWAs, or any other pegged asset.
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