Repeg Mechanism

The core economic engine for most algorithmic repegs. When the stablecoin trades below peg (e.g., at $0.98), the protocol allows users to burn the stablecoin in exchange for a greater value of collateral or a minting right for a sister volatile asset (like LUNA for UST). This creates a profitable arbitrage loop that reduces supply and increases demand, pushing the price back up. Conversely, a price above peg incentivizes minting new stablecoins to increase supply.

For collateralized stablecoins (e.g., DAI, LUSD), the repeg is enforced by the collateralization ratio. If the value of the backing assets falls, positions become undercollateralized. The mechanism automatically triggers liquidations, where a borrower's collateral is sold to repay the debt and burn the stablecoin, contracting supply to defend the peg. Stability fees (interest rates) are also adjusted to manage minting demand.

Many protocols delegate key repeg parameters to decentralized governance. Token holders vote to adjust:

• Stability fee rates
• Liquidation penalties
• Collateral asset types and ratios
• Arbitrage mint/burn functions This allows the system to adapt to new market conditions, but introduces latency and reliance on voter participation and foresight.

Advanced systems use layered defense. The MakerDAO model combines:

• Primary Collateral (e.g., ETH, wBTC)
• Stability-focused assets in a Peg Stability Module (PSM) that holds direct off-chain stablecoins (USDC) for 1:1 swaps.
• Surplus/Deficit buffers from system fees. This structure provides multiple levers for repegging, where the PSM acts as a fast, deep liquidity pool for arbitrage during normal operations.

A critical failsafe feature. If deviation is severe and sustained, threatening systemic solvency, a circuit breaker or emergency shutdown can be triggered. This halts normal minting/burning and enables an orderly wind-down, settling all positions based on a final recorded collateral price. It's a last-resort mechanism to preserve value and allow for a controlled repeg or redemption event.

A primary trigger occurs when the stablecoin's market price deviates beyond the predetermined tolerance band of its Peg Stability Module (PSM). This module uses arbitrage incentives, but if the price remains outside the band (e.g., >$1.01 or <$0.99) for a sustained period, the protocol may initiate a repeg to forcibly adjust the redemption price and restore the peg.

• Example: If USDC depegs to $0.90 and arbitrage fails, the protocol may execute a negative repeg, lowering the redemption price to match market reality and incentivize burning.

For collateralized stablecoins (like those using ETH or LSTs), a repeg can be triggered if the system's collateralization ratio falls below a critical safety minimum. This indicates insufficient backing for the outstanding stablecoin supply.

• Mechanism: The protocol may execute a global settlement or a negative repeg to reduce the redemption value of each stablecoin, effectively writing down debt to realign the system with its actual collateral value and prevent a bank run.

Protocols rely on oracle price feeds (e.g., Chainlink, Pyth) for the market price of their stablecoin and collateral. A repeg is often triggered by a governance-approved update based on a Time-Weighted Average Price (TWAP).

• Process: The protocol calculates a TWAP over a set period (e.g., 24 hours) to smooth volatility. If this TWAP shows a persistent deviation, a governance vote or automated keeper can execute a repeg to the TWAP value, making the adjustment data-driven and less susceptible to manipulation.

In many decentralized autonomous organizations (DAOs), a repeg can be initiated directly by a governance vote. This is a manual override used in crisis scenarios where automated mechanisms are insufficient or too slow.

• Use Case: Faced with a severe, sustained depeg and potential protocol insolvency, token holders vote to enact a one-time adjustment to the redemption price. This decisive action aims to restore confidence and long-term viability, though it carries significant governance and reputational risk.

Pure algorithmic stablecoins (without direct collateral) use expansionary and contractionary monetary policy. A repeg here is a fundamental recalibration of the system's target price or growth rate.

• Trigger: Persistent failure of seigniorage shares or bonding mechanisms to maintain the peg signals a flawed equilibrium. The protocol governance may vote to change the target price (e.g., from $1.00 to $0.80) or the rebase parameters, effectively executing a repeg to find a new, sustainable market-clearing price.

In Collateralized Debt Position (CDP) systems like MakerDAO, a negative repeg (called a Global Settlement) can be triggered if the system cannot liquidate underwater vaults fast enough during a market crash.

• Mechanism: When the system's total bad debt exceeds a catastrophic threshold, governance can freeze the protocol and trigger a settlement. All DAI becomes instantly redeemable for a fixed amount of underlying collateral (e.g., 0.85 worth of ETH per DAI), finalizing the repeg and allowing holders to claim assets directly.

The most common method, which relies on market participants (arbitrageurs) to correct price deviations. When a stablecoin trades below its peg, the protocol allows users to redeem it for more valuable collateral at a profit, increasing demand and pushing the price up. Conversely, when above peg, users can mint new stablecoins cheaply, increasing supply to lower the price. This method is fundamental to algorithmic stablecoins like Frax and requires robust, liquid secondary markets.

The protocol's treasury or a dedicated market operations module actively buys and sells the stablecoin on decentralized exchanges (DEXs) to stabilize the price. This involves using reserve assets to:

• Buy back stablecoins when the price is below target, reducing supply.
• Sell stablecoins or mint new ones when the price is above target, increasing supply. This method provides a more direct and immediate intervention, similar to a central bank's open market operations, but requires significant capital reserves.

The protocol algorithmically adjusts the staking yield or borrowing costs associated with the stablecoin to influence supply and demand. For example:

• If the stablecoin is below peg, the protocol increases rewards for stakers or lenders, incentivizing users to lock up supply and reduce circulating tokens.
• If above peg, the protocol may increase minting fees or lower rewards, discouraging new supply. This method is often used in decentralized money markets and lending protocols to manage peg stability indirectly.

Used by collateralized and hybrid stablecoins, this method changes the required ratio of collateral backing each stablecoin. To defend a de-pegging event:

• If the stablecoin is undercollateralized and below peg, the protocol may temporarily increase the collateral ratio requirement for new mints, strengthening the backing.
• Some protocols have a recapitalization mechanism (like MakerDAO's Emergency Shutdown) that allows the system to be settled at the current collateral value if the peg is severely threatened.

Repeg mechanisms rely on arbitrageurs to correct price deviations by creating profitable opportunities. The core security question is whether the protocol's incentives are sufficient and correctly aligned to trigger this behavior under all market conditions. Flawed incentive design can lead to failed repegs or permanent depeg.

• Example: A protocol may offer discounted collateral to arbitrageurs who burn depegged tokens, but if the discount is too small during high volatility, the mechanism fails.

Many repeg mechanisms involve minting/burning tokens against collateral reserves. The security of the repeg is directly tied to the liquidity, quality, and custody of these reserves.

• Liquidity Risk: Insufficient liquid reserves prevent arbitrageurs from exiting their positions, stalling the repeg.
• Custodial Risk: Centralized reserve custody introduces counterparty risk and single points of failure.
• Example: A depegged algorithmic stablecoin may rely on a volatile secondary token as collateral, creating a reflexive death spiral during a repeg attempt.

Repeg logic is triggered by off-chain price data from oracles. This creates a critical dependency and attack surface.

• Oracle Failure: If the price feed lags, halts, or provides incorrect data, the repeg mechanism cannot function correctly.
• Oracle Manipulation (Flash Loan Attacks): An attacker could temporarily manipulate the oracle price to trigger an unnecessary or disadvantageous repeg, extracting value from the system.
• Robust mechanisms use time-weighted average prices (TWAP) and multiple oracle sources to mitigate this.

The parameters controlling a repeg (e.g., fee rates, collateral ratios) are often set by protocol governance. This introduces risks:

• Governance Attack: A malicious actor gaining control of governance tokens could disable or sabotage the repeg mechanism.
• Speed vs. Security Trade-off: Emergency repeg actions via multisig are faster but increase centralization risk. Fully on-chain, time-delayed governance is more secure but slower to react.
• The choice between these models is a fundamental security consideration.

A repeg attempt can create reflexive feedback loops that destabilize the broader ecosystem, especially for algorithmic designs.

• Death Spiral: Selling pressure on the depegged token to restore the peg can crash the value of its backing collateral, worsening the depeg.
• Contagion Risk: A failed repeg on a major stablecoin can trigger liquidations and volatility across connected DeFi protocols and lending markets.
• These risks are non-linear and difficult to model, representing a systemic security concern.

The repeg mechanism is implemented in smart contract code, which must execute flawlessly under extreme network conditions and economic stress.

• Code Vulnerabilities: Bugs in the mint/burn or price calculation logic can be exploited, leading to fund loss.
• Front-Running: Transparent on-chain transactions allow MEV bots to front-run arbitrage trades, capturing most of the profit and reducing the mechanism's effectiveness.
• Gas Cost Sensitivity: During network congestion, high gas fees can make small arbitrage opportunities unprofitable, crippling the repeg.