Pegging & De-Pegging of Stablecoins: Unfolding the Reason Behind Recent USDC De-pegging

Recently, there has been a lot of talk about stablecoins, particularly the Pegging & De-pegging of Stablecoins or one of the most popular stablecoins, USDC. 

Basically, stablecoins are a type of cryptocurrency that aims to maintain a stable value against a pegged asset, such as the US dollar, by backing the token with reserves of the underlying asset. However, stablecoins are not immune to market volatility. And can sometimes lose their peg, which can have significant implications for traders and investors.

In this blog post, we will explore what pegging and de-pegging mean in the context of stablecoins, and what the recent de-pegging of USDC means for the crypto industry.

Pegging & De-Pegging of Stablecoins: What is Pegging in the Crypto Industry?

Pegging in cryptocurrency refers to anchoring the underlying asset’s value to an external asset. It is done in order for the pegged asset to mimic the price movements of the other item or currency. 

For example, both USDC and USDT are tied to the US dollar. This indicates that one unit of either stablecoin can be exchanged for one dollar. Another example is the PAX Gold Cryptocurrency, which is pegged to the actual price of gold. 

Apart from that, depending on the type of stablecoin, a digital currency is currently pegged using two methods:

Maintaining Reserves: Stablecoins that use this pegging method are referred to as ‘centralized stablecoins.’ Since their value is stored in a centrally managed vault.

For example, Circle is expected to keep one US dollar in its vault for every USDC token sold. A fiat-backed or asset-backed stablecoin is one that is backed by a currency or asset.

Using Algorithms: These stablecoins are not backed by any asset; rather, they are managed by smart contract code. This keeps the price stable by algorithmically controlling demand and supply. Terra’s UST was one of several prominent algorithmic stablecoins that collapsed.

Meanwhile, the recent market updates related to the de-pegging of the USDC stablecoin created a buzz in the crypto community regarding why stablecoins de-pegs. So, what exactly is de-pegging, and what factors lead a stablecoin to lose its peg?

What is De-pegging in the Crypto Industry?

In the crypto industry, de-pegging refers to the separation of a cryptocurrency’s value from a pegged asset. Many stablecoins are pegged to the value of the U.S. dollar or other fiat currencies. 

De-pegging occurs when the value of the stablecoin diverges significantly from the value of the pegged asset. This triggered the stablecoin to lose its peg and become more volatile. De-pegging can occur for various reasons, such as market fluctuations, and changes in the supply and demand of the stablecoin. In addition, it can also transpire due to changes in the value of the pegged asset. 

However, when a stablecoin de-pegs, it can result in significant losses for investors who may have expected the stablecoin to maintain its peg. In addition, it can also impact the wider crypto market, as it can lead to increased volatility and uncertainty.

The Unpredictable Nature of Stablecoins: A Deep Dive into Why De-Pegging Occurs

Stablecoins generally de-peg due to a combination of micro and macroeconomic reasons. Micro variables include changes in market conditions, such as a sudden spike or reduction in stablecoin demand, liquidity issues, and changes to the underlying collateral. Macro variables are changes in the general economic landscape, such as inflation or interest rate hikes.

For example, if demand surges owing to increased cryptocurrency trading activity, the price of a stablecoin may temporarily exceed its fixed value. However, if there is insufficient liquidity to meet increased demand, the stablecoin’s price may fall below its fixed value.

On the macroeconomic side, if there is high inflation, the purchasing power of the underlying assets that support the stablecoin may fall, resulting in a de-peg event. Similarly, changes in interest rates or other macroeconomic variables may have an impact on stablecoin demand.

In addition, Stablecoins can also de-peg due to regulatory changes or legal difficulties. For example, if a government prohibits the usage of stablecoins, demand for the stablecoin will plummet, lowering its value. 

Apart from that, a de-pegging event can also be triggered by technological issues. The issues include smart contract errors, hacking assaults, and network congestion. For example, a smart contract error might cause the stablecoin’s value to be computed incorrectly, resulting in a significant deviation from its peg.

Correlating the Whole Scenario with the recent De-pegging of USDC

USDC is a completely reserved-backed stablecoin, which means that every USD Coin is backed by actual cash and short-dated US Treasury bills. Despite this, USDC issuers Circle announced on March 11 that USDC has de-pegged from the US dollar. With around $3.3 billion of its $40 billion in USDC reserves held in the now-defunct Silicon Valley Bank. 

Pegging and De-pegging of Stablecoins

Silicon Valley Bank was one of Circle’s six banking sector partners with whom they were collaborating to manage their 25% cash reserves. Meanwhile, with USDC’s collateral influence, several other stablecoins also followed suit in decoupling from the US dollar.

Along with this, prominent crypto exchanges began suspending USDC conversions on their exchanges due to their uncertainty about USDC’s financial position and its peg to the US dollar. Both Binance & Coinbase announced that they would temporarily suspend USDC conversions.

However, in just two days, the USDC stablecoin regained its peg to the US dollar. This re-pegging came after the federal banking and finance regulators announced a development. They said that all Silicon Valley Bank depositors will be made whole and will have access to their funds in the next coming days.

The above-transpired de-pegging is the perfect example of a macroeconomic factor leading the second-largest stablecoin to lose its peg. To that end, experts believe that this continuous de-pegging of stablecoins in the past few years is creating a sense of FUD in the crypto industry, which must be addressed. 

Conclusion

Stablecoins are an essential tool for facilitating trades and payments for cryptocurrencies, particularly the more volatile ones. These provide advantages like low-cost cross-border trade, prompting several countries to investigate these systems.

Meanwhile, cryptocurrency is still in its early phase and unregulated. This implies that such currencies are more likely to face the heat of the market in the near future. To mitigate such risks, investors should maintain a diverse stablecoin portfolio.

To know more about what the Pegging & De-pegging of Stablecoins is, go check out SunCrypto Academy.

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