Last week, the collapse of the SVB Financial Group caused a broader bank failure on Wall Street. This event significantly impacted the crypto market, with Bitcoin (BTC) and many altcoins performing well. However, not all of the crypto sector enjoyed the benefits of this event, as stablecoin USDC experienced a de-pegging event in the week.
Stablecoins are digital assets that aim to maintain a stable value that aligns with their original backing assets, such as the US dollar or even precious metals like gold.
Factors that Affect Stablecoin Peg
Many factors can cause stablecoins to change their peg, either up or down. One such instance is the USDC, which is backed by USD reserves and 2-year treasuries and should always be at the one-dollar mark.
However, a significant shortage in demand for the stablecoin may prevent the coin from losing or gaining value, depending on the situation. De-pegging is a phenomenon where a stablecoin’s value falls below its peak, undermining its utility and trust in the stablecoin.
This event can be a significant problem for users who rely on stablecoins for fast global transactions while maintaining stability and predictability. Stablecoins aim to provide a reliable alternative to traditional currencies by avoiding the typical volatility of other cryptocurrencies.
Lack of Market Liquidity
Stablecoins are digital assets that aim to maintain a fixed value relative to their backing asset, such as the US dollar. However, to maintain this peg, stablecoins need enough market liquidity to consolidate their value. Market liquidity measures how quickly an asset can be traded without affecting its price. If fewer buyers and sellers exist, the stablecoin’s value can differ from its peg.
Market liquidity plays a critical role in maintaining the stability of stablecoins. When there is a high and increasing demand for a particular stablecoin, market liquidity ensures the coin can be traded quickly, helping consolidate its value.
However, when there is a low demand for a stablecoin, the lack of liquidity can lead to a de-pegging event, undermining the trust in the coin and its utility. In the past week, we have seen an example of a de-pegging event in the stablecoin USDC, which lost its peg and dropped to $0.88.
This USDC event was due to the collapse and subsequent closure of two banks, Silvergate and Signature, that supported the crypto world. This event highlights the importance of market liquidity in maintaining the stability of stablecoins.
Market Manipulation
Market manipulation is a problem that affects any form of currency, including stablecoins. In 2017, the stablecoin USDT or Tether was accused of manipulating the price of Bitcoin by issuing more USDT than they had in reserves. Researchers found evidence that USDT was used to buy BTC at low moments, creating an artificial demand that drove up the price of Bitcoin.
Design Flows
Stablecoins use algorithms as part of a broader mechanism to maintain their pegs to their underlying assets. This mechanism includes collateralization and governance to account for additional risks and ensure security and stability.
However, these mechanisms could be better, and stablecoins can still experience significant fluctuations in their pegs. In 2022, TerraUSD and Luna saw their pegs plummet from the $1 peg due to various failures in their mechanisms. As a result, the LUNA ecosystem suffered a massive implosion, losing over $60 billion in valuation.
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