Peg

The most common method for backing a stablecoin's value. The peg is maintained by holding a reserve of assets equal to or greater than the circulating supply.

• Fiat-Collateralized: Reserves are held in bank accounts (e.g., USDC, USDT).
• Crypto-Collateralized: Overcollateralized with other cryptocurrencies to absorb volatility (e.g., DAI, backed by ETH).
• Commodity-Collateralized: Backed by physical assets like gold.

Uses on-chain algorithms and smart contracts to control supply, expanding or contracting it to move the market price toward the peg. This method does not rely on traditional collateral reserves.

• Rebasing: Adjusts the token balance in every holder's wallet (e.g., early Ampleforth).
• Seigniorage: Mints new tokens when price is above peg to sell for profit, and burns tokens or issues bonds when below peg (e.g., the original TerraUSD model).

A critical feature that allows users to directly exchange the pegged asset for its underlying collateral at the pegged rate. This creates a fundamental arbitrage opportunity that enforces the price floor.

• 1:1 Redemption: A holder of 1 USDC can always redeem it for $1 from the issuing entity's reserves.
• For crypto-backed stablecoins: Users can liquidate their collateralized debt positions to reclaim underlying assets, which helps maintain the soft peg.

Essential for any peg that references an external asset. Decentralized oracles provide real-time, tamper-resistant market price data to the smart contracts that manage the peg.

• On-Chain Reference: The protocol's stabilization mechanisms (minting, burning, liquidation) are triggered based on this external price data.
• Attack Vector: Manipulation of the oracle price (an "oracle attack") can break the peg by providing false data to the system.

The resilience of a peg is measured by its historical deviation from the target price. A depeg occurs when the market price significantly and persistently diverges.

• Common Causes: Collateral insolvency, bank failure (for fiat-backed), loss of algorithmic confidence, smart contract exploit, or oracle failure.
• Example: In May 2022, TerraUSD (UST) lost its dollar peg and entered a "death spiral," collapsing to near zero.

Describes the rigidity of the exchange mechanism.

• Soft Peg: The value is algorithmically or market-incentivized to approximate a target, with occasional fluctuations (e.g., DAI, FRAX). It's maintained by decentralized mechanisms.
• Hard Peg: A fixed, legal, or direct redeemable guarantee of value, typically enforced by a centralized entity (e.g., traditional fiat-backed stablecoins). The entity promises direct redemption.

The primary security of a collateral-backed peg (like DAI or USDC) depends on the value and liquidity of its underlying assets. Risks include:

• Undercollateralization: If the value of the collateral falls below the value of the issued stablecoins, the peg can break.
• Collateral Liquidity: In a crisis, a lack of liquid markets for the collateral (e.g., real-world assets) can prevent timely redemptions.
• Concentration Risk: Over-reliance on a single type of collateral (e.g., commercial paper) creates systemic vulnerability.

Algorithmic stablecoins (e.g., Terra's UST) maintain their peg through on-chain code and incentive mechanisms, introducing unique failure modes:

• Death Spiral: A loss of confidence triggers sell pressure, breaking the arbitrage mechanism and causing hyperinflation in the governance token.
• Oracle Manipulation: Peg stability often relies on price oracles. If these are compromised, the system can be gamed.
• Governance Attacks: Malicious actors could exploit governance token holdings to pass proposals that destabilize the protocol.

Many fiat-backed stablecoins (e.g., USDT, USDC) rely on centralized entities to hold reserves and manage issuance/redemption. This introduces:

• Counterparty Risk: Users must trust the issuer to hold the promised reserves and honor redemptions.
• Regulatory Seizure Risk: Reserve assets held in traditional banks are subject to government seizure or freezing.
• Censorship Risk: The issuer can blacklist addresses, preventing them from using the stablecoin.

A peg's stability is ultimately enforced by market arbitrage, which requires deep, continuous liquidity.

• DEX Liquidity Fragmentation: If liquidity is spread too thin across many pools, large trades can cause significant price slippage away from the peg.
• Redemption Bottlenecks: Limits on daily redemption amounts or high fees can prevent efficient arbitrage during stress.
• Depegging Events: Historical examples include UST's collapse (2022) and DAI's brief depeg during the March 2020 market crash.

The technical infrastructure supporting pegged assets is a critical attack surface.

• Smart Contract Vulnerabilities: Bugs in the minting, redemption, or rebasing logic can be exploited to drain funds or break the peg.
• Cross-Chain Bridge Risk: Wrapped versions of stablecoins (e.g., USDC.e) depend on the security of often-complex bridge contracts, which have been frequent targets for hacks.
• Upgradeability Risk: Protocols with upgradeable proxy contracts carry the risk of a malicious or buggy admin update.

A cryptocurrency that maintains its peg through on-chain algorithms and smart contracts, not direct collateral. It uses mechanisms like seigniorage shares or rebasing to algorithmically expand or contract the token supply in response to market demand.

• Example: Terra's UST (historical) used a burn-and-mint mechanism with its governance token, LUNA.
• Key Feature: Typically aims for capital efficiency by minimizing reliance on external collateral.

A stablecoin that maintains its peg by being backed by a reserve of assets. The value of the collateral must meet or exceed the value of the issued stablecoins.

• Fiat-Collateralized: Backed by off-chain reserves (e.g., USDC, USDT).
• Crypto-Collateralized: Overcollateralized with on-chain crypto assets (e.g., DAI, LUSD) to absorb price volatility.
• Key Mechanism: Redemption rights allow users to exchange the stablecoin for the underlying collateral, enforcing the peg.

A peg that allows for a target price band or range of fluctuation, rather than a rigid, fixed price. The monetary authority or protocol intervenes to stabilize the price within the band.

• Example: A central bank managing a currency within a crawling peg or target zone.
• Blockchain Context: Some algorithmic stablecoin designs tolerate minor deviations, using gradual rebase mechanisms instead of instant arbitrage.

A peg that aims for a 1:1 fixed exchange rate with the target asset, with minimal to no tolerance for deviation. Maintenance often requires immediate, powerful arbitrage opportunities or direct redemption.

• Primary Example: Fiat-collateralized stablecoins like USDC target a hard peg to the US Dollar.
• Enforcement: Relies on constant arbitrage and guaranteed redemption at the fixed rate to correct any price drift.

An event where an asset deviates significantly from its intended peg, breaking the fixed exchange rate. This indicates a failure of the stabilizing mechanism.

• Causes: Can be triggered by a bank run, collateral insolvency, liquidity crisis, or a flaw in the algorithmic design.
• Consequence: Often leads to a death spiral for algorithmic models or a loss of user confidence in collateralized models.

The primary market force that enforces a peg. Traders profit from price differences between markets, which pushes the price back to its target.

• Mechanism: If a stablecoin trades below $1, arbitrageurs buy it cheaply and redeem it for $1 of collateral, making a profit and reducing supply.
• Critical Role: The efficiency and cost of arbitrage are fundamental to peg stability. Protocols design incentives to make this process frictionless.