Depeg: the anatomy of losing a peg and why panic is a mechanism

A depeg - a stablecoin's deviation from $1 - has happened to every issuer, including the most regulated ones. March 2023: USDC dropped to $0.87 on news that reserves were stuck at the collapsed Silicon Valley Bank. The mechanics are instructive.

How a depeg unfolds

The trigger is doubt about collateral (news about reserves, a hack, a regulatory strike). The first to run are those closest to the information: they sell the stablecoin into DEX pool and order book liquidity. The price sags - and that's when panic becomes rational: if there's a chance reserves are insufficient, exiting at $0.95 beats exiting at $0.50. A classic bank run, just at blockchain speed: pools get skewed within minutes.

Who profits

Arbitrageurs with strong nerves and an understanding of the situation: if the issuer is solvent, buying at $0.9 with a subsequent redemption at $1 is the trade of the year (the USDC case confirmed this: the peg returned within days once authorities guaranteed SVB deposits). If the issuer is insolvent (UST), the "cheap stablecoin" keeps getting cheaper until it hits zero. The whole game is telling the two apart faster than the crowd.

For holders

• Diversifying across stablecoins isn't paranoia - it's hygiene.
• Know your stablecoin's redemption mechanism: those with direct redemption at the issuer sleep more soundly.
• At the moment of a depeg, the decision should be based on the quality of the reserves, not on the depth of the drawdown.