Stablecoin Peg

The most common peg mechanism, where each stablecoin is backed by real-world assets held in reserve. This includes:

• Fiat-Collateralized (e.g., USDC, USDT): Backed 1:1 by cash and cash equivalents in bank accounts.
• Crypto-Collateralized (e.g., DAI): Backed by over-collateralized crypto assets (e.g., ETH) locked in smart contracts to absorb price volatility.
• Commodity-Collateralized: Pegged to the value of physical assets like gold.

A peg maintained by smart contract algorithms that automatically expand or contract the token supply, with minimal or no collateral. Mechanisms include:

• Rebasing: Adjusts the token balance in every wallet to target the peg (e.g., Ampleforth).
• Seigniorage: Uses a multi-token system where a secondary, volatile token is minted or burned to stabilize the primary stablecoin's price. This model is non-custodial but carries significant depeg risk if demand collapses.

The foundational guarantee that allows users to exchange the stablecoin for its underlying peg asset at the fixed rate. This creates arbitrage incentives to correct price deviations.

• Direct Redemption: Users can redeem 1 USDC for $1 from the issuing entity (Circle).
• On-Chain Liquidity Pools: For crypto-collateralized stablecoins like DAI, users mint/burn against locked collateral via smart contracts. A credible, low-friction redemption process is critical for peg integrity.

The peg's resilience to market stress. Stability is measured by the deviation from the target price (e.g., $1.00). Key risk factors include:

• Collateral Liquidity: Can reserves be sold quickly without loss? (e.g., Silicon Valley Bank's impact on USDC).
• Smart Contract Risk: Bugs in mint/burn or oracle logic.
• Governance Attacks: Malicious proposals to drain collateral.
• Loss of Confidence: A bank run scenario where redemption demand exceeds reserve liquidity.

Critical infrastructure that provides the external market price data smart contracts need to manage the peg. Oracles determine when to trigger minting, burning, or liquidation events.

• DAI's PSM: Uses price feeds to allow direct swaps between USDC and DAI at $1.
• Algorithmic stablecoins: Rely on oracles to calculate supply adjustments. Oracle manipulation or failure is a primary attack vector for breaking a peg.

The control structure that manages peg parameters, collateral types, and emergency responses. This exists on a spectrum:

• Centralized (Custodial): A single entity (Tether, Circle) controls all reserves and mint/burn functions.
• Decentralized (DAO): Token holders vote on changes (e.g., MakerDAO governance for DAI's stability fee, collateral types). Governance decisions directly impact the peg's credibility, censorship-resistance, and upgrade path.

For fiat-collateralized stablecoins like USDC, the primary risk is custodial failure. This includes:

• Counterparty Risk: Reliance on a central issuer to hold and manage the reserve assets.
• Regulatory Seizure: Government action could freeze or seize the underlying reserves.
• Transparency Gaps: Inadequate proof-of-reserves auditing can obscure mismanagement or insolvency. The peg fails if the issuer cannot redeem tokens 1:1 for the underlying asset.

Overcollateralized stablecoins (e.g., DAI) rely on smart contracts and price oracles to maintain solvency. Key risks include:

• Liquidation Engine Failure: If the system cannot liquidate undercollateralized positions fast enough during a market crash, the protocol becomes insolvent.
• Oracle Attack: Manipulation or failure of the price feed can trigger incorrect liquidations or allow unsafe borrowing.
• Collateral Volatility: A sharp, correlated drop in the value of all accepted collateral assets (e.g., ETH) can overwhelm the system's safety buffers.

Algorithmic stablecoins (e.g., former UST) use on-chain mechanisms, not direct collateral, to maintain the peg. Their core vulnerability is reflexivity:

• Death Spiral: A drop in the stablecoin's price triggers algorithmic minting/burning of a companion governance token, whose falling price further erodes confidence in the peg.
• Ponzi-like Dynamics: Stability often depends on continuous new capital entering the system to absorb sell pressure.
• Anchor Rate Dependence: Pegs tied to high yield promises are vulnerable when those yields are unsustainable.

All stablecoins face secondary market risks that can break the peg, even if the primary mechanism is sound.

• Centralized Exchange (CEX) Depegs: A lack of liquidity or halted withdrawals on a major exchange can cause a temporary, localized price deviation.
• Redemption Bottlenecks: If on-chain redemption is slow, costly, or limited, arbitrage cannot efficiently correct price deviations.
• Concentration Risk: A single large holder (whale) dumping can overwhelm available market depth, especially for newer or smaller-cap stablecoins.

Decentralized stablecoins are governed by DAO token holders, introducing unique risks:

• Governance Attacks: An entity acquiring a majority of governance tokens could change critical parameters (e.g., collateral types, fees) to their benefit.
• Upgrade Vulnerabilities: A malicious or buggy governance proposal could introduce exploitable code during a protocol upgrade.
• Decision Latency: The time required to execute on-chain governance votes can prevent a rapid response to a developing crisis.

Stablecoin issuers operate in an evolving regulatory landscape, creating systemic peg risks.

• Reserve Asset Classification: If regulators deem a stablecoin's reserves to be securities, it could force a disruptive asset liquidation.
• Issuer Licensing: An enforcement action against an unlicensed issuer can halt minting/redemption operations.
• Sanctions Compliance: The need to blacklist addresses can conflict with censorship-resistant redemption guarantees, undermining trust in the peg's neutrality.

The practice of backing a stablecoin's value with reserve assets. This is the primary mechanism for fiat-collateralized and crypto-collateralized stablecoins.

• Over-collateralization: Requires more collateral than the stablecoin's value (e.g., 150% for DAI) to absorb price volatility.
• Asset Types: Reserves can be fiat currency, other cryptocurrencies, or commodities.

A non-collateralized method using smart contracts and tokenomics to maintain the peg through supply adjustments.

• Rebasing: Algorithmically adjusts the token supply in user wallets to target the peg.
• Seigniorage: Mints new tokens when above peg to sell for profit, and burns tokens or sells bonds when below peg to reduce supply.
• Key Risk: Relies on continuous market demand and can fail in a bank run scenario.

The primary market force that corrects price deviations from the peg. Traders profit from the difference, which pushes the price back to its target.

• Above Peg: Users can mint new stablecoins at $1 and sell them on the open market for a profit, increasing supply.
• Below Peg: Users can buy discounted stablecoins and redeem them for $1 worth of underlying assets, reducing supply.
• This mechanism is critical for both collateralized and algorithmic models.

Occurs when a stablecoin's market price significantly and persistently deviates from its intended peg (e.g., trading at $0.90 or $1.10).

• Causes: Can be triggered by collateral failure, smart contract exploits, loss of market confidence, or liquidity crises.
• Historical Examples: UST's collapse (algorithmic), USDC's brief depeg during the 2023 banking crisis (collateral concern).

A critical data feed that provides external, real-world price information to a blockchain. Essential for maintaining accurate pegs.

• Function: Supplies the current market price of the stablecoin and its collateral to smart contracts.
• Use Case: Determines when to trigger liquidation of undercollateralized positions or supply adjustments in algorithmic systems.
• Security: A compromised or manipulated oracle is a major systemic risk.

A decentralized reservoir of tokens locked in a smart contract, enabling seamless trading and price discovery on Decentralized Exchanges (DEXs).

• Role in Peg Stability: Deep liquidity allows for large trades with minimal slippage, making arbitrage more efficient and helping to maintain the peg.
• Liquidity Provider (LP): Users who deposit tokens into the pool to earn trading fees, but are exposed to impermanent loss.