Peg and depeg are popular terms that have been used quite commonly since the “Luna 1.0 collapse” happened. But not everyone can understand the definition of peg or depeg, especially for those who are newcomers to the crypto market. So what is peg? And what happens when a cryptocurrency loses its peg? Let’s find out together!
What is peg?
Peg is a mechanism that is often used when a coin has its value pegged to another medium of exchange, usually USD, with a ratio of 1:1. The value of the cryptocurrency will then fluctuate in the same direction and to the same extent as the currency in which it is pegged.
Most stablecoins are pegged to the value of the USD, as it is a common currency used in the worldwide economy. Some stablecoins can be mentioned as USDT, UST, USDC, DAI, etc. They are all pegged at a 1:1 ratio against USD. In addition, cryptocurrencies can theoretically be pegged to any kind of asset such as gold or any country’s currencies.
The cryptocurrency market is well-known for its volatility. The top coins, like Bitcoin and Ethereum, or altcoins have all experienced severe declines since the golden stage in November 2021. Thus, the cryptocurrency which is designed to peg into a stable asset can retain value and avoid negative effects for anyone who are holding these coins.
What happens when a coin loses its peg?
In order to stabilize their value, stablecoins often use collateral, which can be fiat, crypto, or other assets. However, in some cases, due to mass sell-offs, stablecoins can fall significantly in price from the value they are pegged to. That’s called “depeg.”
Depeg is able to trigger a chain reaction. First, top investment funds will start liquidating coins to recover their capital. Next, individual investors will panic and start selling, resulting in a more severe peg loss. Finally, the project team has to liquidate collateral to maintain the value of the pegged coin. If the asset cannot or is not sufficient to be liquidated, the coin will gradually lose value depending on the severity of the event. In addition, the depeg of stablecoins can trigger a domino effect, affecting negatively the whole crypto market.
Some typical depeg cases
TerraUSD – UST
UST is Terra’s algorithmic stablecoin, its value is pegged to USD at a 1:1 ratio. Terra reserved a certain amount of LUNA as collateral for the UST. When UST exceeded 1 USD, the Terra protocol encouraged burning LUNA to mint UST and vice versa. By that protocol, the UST price was maintained.
However, the beginning of the UST’s collapse started with a sell-off of whales worth $285 million on May 7 and 8, 2022, causing the price of UST to drop to $0.98. After that, this event triggered a series of withdrawals from DeFi platforms and a sell-off of UST coins across the market due to panic among investors. Although Terra continuously minted LUNA to save the UST price, this mechanism killed the whole project. UST and LUNA prices have now lost more than 99.9% of their value, reaching $0.007 and $0.000058 respectively at the time of this writing.
stETH is a token that is pegged to ETH at a 1:1 ratio and is utilized on Lido. When users stake ETH, stETH will be minted and paid as interest. And when stETH is exchanged for ETH, it will be burned from the circulating supply.
Celsius is a cryptocurrency lending company and one of Lido’s customers. This company allows users to stake stETH to receive an APR of 18%. The problem occurred when there were 2 wallets withdrawing 54,103 ETH each on June 8, causing the price of stETH to drop to 0.97 ETH.
After that, Alameda Research sold all their stETH to ETH in 2 pools, Lido and AAVE. Other investors, including Amber Group, also swapped 83k stETH for capital safety. That led to a domino effect on other DeFi projects.
On June 13, Celsius announced it would suspend withdrawals, swaps, and transfers between accounts. Celsius no longer has enough liquidity after the crash as many investors have been swapping stETH for ETH uncontrollably. At this time, Celsius only holds 27% of ETH, corresponding to liquidity of nearly 26k ETH. The remaining 73% is currently not withdrawable, including 44% stETH and 29% ETH2 staking.
USDD is a TRON algorithmic stablecoin, with the same operating mechanism as UST. TRX and USDD will be minted or burned back and forth at a rate of 30%. The crypto market has been relatively volatile in recent days. And the depeg of stETH has put USDD on fire. On June 13, USDD was sold off, causing the coin to lose its peg at $0.977 compared to previous days.
The issue got worse and worse as the USDD price showed no signs of recovery and continued to drop to $0.956 USD on June 15, according to CoinMarketCap. Therefore, Tron DAO had to approve a fund of 700 million USDC into the market to recover the USDD price to $0.99. However, this incident also caused TRX to be seriously affected and fell by 16% compared to the time before the USDD depeg had taken place.
Peg is a commonly used price stabilization mechanism and offers many practical benefits to holders and traders. However, if a top coin loses its peg, there will be various risks related to asset loss, loss of reputation, and the domino effect spreading out to the whole crypto market.