Price Peg

The foundational asset reserve that guarantees the value of the pegged token. This can be:

• On-Chain Collateral: Crypto assets (e.g., ETH, BTC) held in smart contracts, often over-collateralized for stability.
• Off-Chain Reserves: Fiat currency or commodities held by a centralized entity and audited.
• Algorithmic: No direct collateral; relies on seigniorage shares and supply contraction/expansion algorithms.

The smart contract logic that programmatically adjusts the token supply to influence price.

• Minting: Creates new pegged tokens when demand is high, often by depositing collateral.
• Burning: Destroys pegged tokens to reduce supply when the price falls below the peg, often to reclaim collateral. This is the primary tool for algorithmic stablecoins and a key function in collateralized models.

A trusted source of external market price data fed into the peg system's smart contracts. It determines when minting or burning actions are required.

• Decentralized Oracles: Use aggregated data from multiple exchanges (e.g., Chainlink).
• Centralized Feed: A single, often permissioned, price feed. Oracle reliability is critical; a faulty price feed can trigger incorrect monetary policy, breaking the peg.

Economic rewards designed to encourage third-party traders to correct price deviations.

• If the token trades above peg, arbitrageurs can mint it cheaply and sell it on the open market for a profit, increasing supply and pushing the price down.
• If it trades below peg, they can buy it cheaply and burn it to redeem higher-value collateral, reducing supply and pushing the price up. This leverages market forces to enforce the peg.

The rules and decision-making process that controls the peg system.

• Parameters: Configurable values like collateral ratios, stability fees, and oracle update intervals.
• Governance: Often managed by a Decentralized Autonomous Organization (DAO) holding governance tokens. It votes on parameter changes, upgrades, and crisis responses (e.g., changing the collateral type).

The guaranteed process for users to exchange the pegged token for its underlying collateral at the peg rate.

• Direct Redemption: Users can always burn 1 unit of the pegged token to claim $1 worth of collateral from the reserve.
• This creates a hard price floor and is a hallmark of fully collateralized systems like MakerDAO's DAI.
• Without a reliable redemption mechanism, the peg relies solely on speculative market confidence.

These assets use on-chain algorithms and smart contracts to manage supply, expanding or contracting it to maintain a peg without direct collateral backing. Examples include:

• Ampleforth (AMPL): Adjusts the wallet balance of every holder daily based on market price.
• Terra's UST (historical): Used a burn-and-mint mechanism with its governance token, LUNA, to absorb volatility.

These systems rely on seigniorage shares models and market incentives rather than reserves.

Tokens pegged to the value of real-world physical assets, providing blockchain-based exposure to traditional markets. Common examples include:

• Gold-Pegged Tokens: Like PAX Gold (PAXG) or Tether Gold (XAUT), where each token represents ownership of a specific amount of physical gold in a vault.
• Real-World Assets (RWA): Tokenized versions of treasury bills, real estate, or other commodities. These pegs bridge traditional finance (TradFi) and decentralized finance (DeFi), offering asset-backed stability.

Mechanisms that maintain a token's value across different blockchain networks or synthetically track an asset's price. This includes:

• Wrapped Assets: Like Wrapped Bitcoin (WBTC) on Ethereum, which is Bitcoin pegged 1:1 via a custodian model.
• Synthetic Assets: Protocols like Synthetix generate synths (e.g., sUSD, sBTC) that track prices via staked collateral and decentralized oracles, without holding the underlying asset. These systems solve interoperability and access problems but introduce custodial or oracle risks.

Maintaining a peg requires active mechanisms and faces inherent risks. Critical components include:

• Arbitrage: The primary force; traders profit by buying when below peg and selling when above, pushing price back to target.
• Oracles: Provide external price feeds for collateral valuation and liquidation triggers.
• De-pegging Risks: Caused by bank run scenarios (fiat-backed), oracle failure, collateral volatility (crypto-backed), or death spirals (algorithmic). Understanding these is essential for assessing any pegged asset's resilience.

A depeg occurs when a stablecoin's market price significantly and persistently deviates from its intended value, most commonly $1.00. This is often triggered by a loss of confidence in the collateral backing or the stability mechanism itself. Key risks include:

• Insufficient Collateralization: The value of the underlying assets falls below the value of the stablecoins issued.
• Collateral Volatility: If backed by volatile assets (e.g., other cryptocurrencies), a market crash can trigger a liquidation cascade.
• Redemption Failure: Inability of users to redeem the stablecoin for its underlying collateral at the promised rate.

Many pegging mechanisms rely on price oracles to determine the value of collateral or to trigger stability functions. Attackers can exploit these dependencies:

• Flash Loan Attacks: Borrow large sums to manipulate the price feed on a decentralized exchange (DEX), tricking the protocol into mispricing assets or executing faulty liquidations.
• Oracle Delay/Latency: Stale price data can cause the system to operate on incorrect information, allowing arbitrageurs to drain funds.
• Oracle Centralization: Reliance on a single or a small set of oracle nodes creates a central point of failure vulnerable to compromise.

Algorithmic stablecoins ("algostables") maintain their peg through seigniorage shares, rebasing mechanisms, or other code-governed rules, without full collateral backing. Their primary risks are reflexivity and death spirals:

• Reflexivity: The peg's stability depends on market confidence in the mechanism itself. A loss of confidence reduces demand, breaking the peg, which further erodes confidence.
• Ponzi-like Dynamics: Some models rely on continuous new user adoption to mint the stabilizing asset, which is unsustainable.
• Governance Attacks: Control over protocol parameters (e.g., mint/burn rates) can be seized via a governance attack, allowing malicious actors to break the peg.

Fiat-collateralized stablecoins (e.g., USDC, USDT) are backed by assets held by a central entity. Their peg security depends on:

• Counterparty Risk: The user must trust the issuer to hold sufficient, high-quality reserves (cash, treasuries) and to honor redemptions.
• Regulatory Seizure/Freeze: Authorities can compel the issuer to freeze addresses or seize assets, breaking the fungibility and utility of the stablecoin.
• Lack of Transparency: Opaque or unaudited reserve reporting can conceal insolvency until a crisis occurs.

A robust peg requires deep, resilient liquidity pools for arbitrage to correct minor price deviations. Key failure modes include:

• Concentrated Liquidity Risk: If liquidity is concentrated in a few pools or on a single chain, a targeted exploit can severely impact the peg.
• Arbitrage Inefficiency: High transaction costs, network congestion, or complex redemption processes can slow or prevent arbitrageurs from correcting the peg.
• Trading Halts: If major centralized exchanges halt trading for a stablecoin during volatility, it removes a critical price discovery and arbitrage venue.

The underlying smart contracts and their integration into DeFi pose inherent risks:

• Smart Contract Bugs: Exploits in the stablecoin's minting, burning, or governance contracts can lead to unlimited minting or fund theft.
• Composability Risk: The stablecoin's integration across hundreds of DeFi protocols (as collateral) means a depeg can trigger systemic contagion, causing liquidations and insolvencies in lending markets and derivatives.
• Upgradeability Risk: Contracts with upgradeable proxies can be changed by administrators, potentially altering the fundamental rules of the system.

The market force that theoretically enforces a price peg by creating risk-free profit opportunities when the asset deviates from its target. Arbitrageurs buy the asset where it's cheap and sell where it's expensive, pushing the price back to parity.

• Stablecoin Example: If USDC trades at $0.98 on one exchange, arbitrageurs buy it and redeem it 1:1 with the issuer for USD, profiting $0.02.
• Liquidity Pools: In DeFi, if a stablecoin pool is imbalanced, arbitrageurs trade to rebalance it, earning fees and correcting the price.

A significant and often rapid deviation of a pegged asset's market price from its intended fixed value (e.g., trading at $0.90 instead of $1.00).

• Causes: Can be triggered by a bank run (mass redemptions), collateral failure, oracle attack, or loss of market confidence in the underlying mechanism.
• Famous Examples: The collapse of TerraUSD (UST) in May 2022 and the temporary depeg of USDC following the Silicon Valley Bank crisis in March 2023. It represents a critical failure of the peg maintenance system.