Hard Peg

A hard peg is typically backed by on-chain collateral held in a transparent smart contract or protocol. The value of this collateral must meet or exceed the value of the issued stablecoins, creating a collateralization ratio of 100% or more. This over-collateralization acts as a buffer against price volatility of the reserve assets.

• Example: MakerDAO's DAI is backed by a surplus of crypto assets like ETH locked in Vaults.
• Transparency: All collateral and debt positions are publicly verifiable on the blockchain.

The peg is maintained through algorithmic mechanisms that autonomously adjust supply. When the price trades above the peg, the protocol incentivizes the creation of new tokens to increase supply and push the price down. When it trades below, mechanisms like buybacks or burning reduce supply to increase the price.

• Seigniorage Models: Protocols like the original Basis Cash used bond and share tokens to absorb supply volatility.
• Rebasing: Some tokens adjust the balance in every holder's wallet proportionally to maintain the peg.

A core feature is the guaranteed right for any holder to redeem their tokens for a fixed unit of the underlying collateral or its value equivalent. This creates an arbitrage loop that enforces the peg: if the market price falls below $1, arbitrageurs can buy the token cheaply and redeem it for $1 of value, profiting and reducing supply.

• Direct Redemption: Redeem 1 token for $1 worth of collateral from the treasury.
• Indirect Arbitrage: Mechanisms that allow profitable trading against a liquidity pool to correct the price.

Unlike centralized stablecoins, a true hard peg aims for decentralization and censorship resistance. The issuance, redemption, and governance of the system are managed by smart contracts and decentralized autonomous organizations (DAOs), not a single entity. This reduces counterparty risk and ensures the system's rules cannot be changed unilaterally to freeze funds or alter redemption terms.

Hard pegs are categorized by their collateral type. Exogenous collateral is external to the protocol's own token (e.g., ETH, BTC, real-world assets). Endogenous collateral is the protocol's own native token, which creates reflexivity and higher risk, as the collateral's value depends on the success of the peg itself.

• Exogenous (Safer): DAI using ETH, USDC using off-chain dollars.
• Endogenous (Risky): UST using LUNA, which led to a death spiral when the peg broke.

All hard peg systems rely heavily on price oracles to determine the accurate market value of both the stablecoin and its collateral. These oracles feed external price data on-chain so the protocol can calculate collateralization ratios and trigger liquidations. This creates a critical external dependency and a potential attack vector if oracles are manipulated or provide stale prices.

A hard peg is typically maintained by a collateral reserve backing the issued tokens. The primary risk is insufficient collateralization, where the reserve's value falls below the total value of tokens in circulation. This can be caused by:

• Asset Devaluation: The reserve assets (e.g., commercial paper, bonds) losing value.
• Custodial Failure: Theft, loss, or mismanagement of the reserve by the custodian.
• Transparency Gaps: Lack of real-time, auditable proof of reserves.

Hard pegs often rely on a centralized issuer or governing body to manage the reserve and mint/burn tokens. This creates single points of failure:

• Censorship: The issuer can freeze or blacklist addresses.
• Regulatory Seizure: Authorities can target the central entity and its reserves.
• Upgrade Control: Governance decisions (e.g., changing collateral types) are concentrated, posing a risk of malicious changes or exploits.

The peg's stability depends on a trustless redemption mechanism allowing users to exchange tokens for the underlying asset at the fixed rate. Key risks include:

• Redemption Gates: The issuer suspending withdrawals during stress, breaking the peg.
• Smart Contract Risk: Bugs in the mint/burn or redemption contracts can be exploited.
• Secondary Market Failure: If the primary redemption is restricted, reliance on decentralized exchanges (DEXs) can lead to a depeg if liquidity dries up.

Some hard pegs use algorithmic components or oracles to manage supply. This introduces distinct attack vectors:

• Oracle Manipulation: Feeding incorrect price data to the protocol can trigger faulty minting or burning.
• Reflexivity Risks: In a crisis, market sell pressure can create a negative feedback loop that the algorithm cannot counteract.
• Death Spiral: If the token depegs, algorithmic burning to restore the peg can collapse demand further, as seen in projects like TerraUSD (UST).

Hard-pegged assets are often viewed as electronic money or securities by regulators, leading to:

• Enforcement Actions: Issuers may face lawsuits or operational shutdowns (e.g., SEC action against Tether).
• Reserve Asset Sanctions: Holdings in the reserve (e.g., Treasury bonds) could be frozen.
• Jurisdictional Arbitrage: Conflicts between regulations in the issuer's, custodian's, and users' jurisdictions create legal uncertainty.

Hard pegs are vulnerable to systemic, unexpected events that can break the peg and cause widespread fallout:

• Bank Runs: A loss of confidence triggers mass redemption requests the reserve cannot meet.
• Correlated Asset Crash: A market-wide crash devalues multiple reserve assets simultaneously.
• Contagion: A depeg of one major stablecoin can trigger panic and liquidity crises across DeFi, which relies on them as collateral (e.g., the collapse of TerraUSD in May 2022).

A soft peg (or crawling peg) is a monetary policy where a currency's value is allowed to fluctuate within a defined range or band relative to an anchor asset, rather than being fixed at a rigid 1:1 ratio. It is managed by a central authority or algorithm that intervenes to stabilize the price.

• Key Difference: Allows for controlled, minor deviations from the target price.
• Example: A central bank might allow its currency to trade within ±2% of the US Dollar.
• Blockchain Use: Some algorithmic stablecoins use soft pegs with rebase mechanisms or seigniorage shares to adjust supply gradually.

Collateralization is the practice of backing the value of a pegged asset (like a stablecoin) with reserves of other assets. It is a foundational method for achieving and maintaining a peg.

• Over-Collateralization: The reserve value exceeds the issued token value (e.g., DAI backed by more than 100% in crypto assets).
• Under-Collateralization / Algorithmic: Relies on algorithms and market incentives rather than full reserve backing (e.g., the original TerraUSD design).
• Reserve Types: Can be fiat-backed (USDC, USDT), crypto-backed (DAI, LUSD), or commodity-backed (gold).

Arbitrage is the simultaneous buying and selling of an asset in different markets to profit from price discrepancies. It is the primary economic force that enforces a hard peg in decentralized systems.

• Peg Maintenance: When a token trades below its peg (e.g., $0.99), arbitrageurs buy it cheaply and redeem it for $1.00 of underlying collateral, driving the price back up.
• Critical Mechanism: For algorithmic or crypto-backed stablecoins, arbitrage opportunities are deliberately designed into the protocol's mint/redeem functions.
• Risk: If arbitrage becomes unprofitable or too risky (e.g., during a bank run), the peg can break.

An oracle is a service that provides external, real-world data (like asset prices) to a blockchain. For hard pegs, price oracles are essential infrastructure for determining the value of collateral and triggering stability mechanisms.

• Function: Continuously feeds the current market price of the pegged asset and its collateral into the smart contracts.
• Liquidation Triggers: In over-collateralized systems, oracles determine when a position is under-collateralized and must be liquidated.
• Central Point of Failure: Oracle manipulation or failure (oracle attack) is a major systemic risk for pegged assets.

A depeg event occurs when a pegged asset significantly and persistently deviates from its target price, indicating a failure of the stabilizing mechanism. It is a critical test of a system's resilience.

• Causes: Can be triggered by a bank run (mass redemptions), collateral value collapse, oracle failure, or a flaw in the algorithmic design.
• Historical Example: The collapse of TerraUSD (UST) in May 2022, which lost its peg and entered a death spiral.
• Response: Protocols may employ emergency shutdowns, recapitalization, or governance interventions to restore the peg.

Fiat currency is government-issued legal tender not backed by a physical commodity (e.g., US Dollar, Euro). It is the most common reference asset for hard pegs, as stablecoins aim to replicate its price stability and utility.

• Target Asset: The vast majority of hard-pegged stablecoins target a 1:1 value with a fiat currency, primarily the US Dollar (USD).
• Reserve Backing: In fiat-collateralized stablecoins, the peg is maintained by holding equivalent reserves in bank accounts or treasury bills.
• Regulatory Nexus: Pegging to fiat brings the asset under the scrutiny of financial regulators concerning money transmission and securities laws.