Depeg

A dollar token is a promise written in code and collateral: one token should be worth about one dollar. A depeg is the moment the market stops believing that promise, in full or in part, and the price slips below the line. Some depegs last minutes. Some never recover.

Why depegs happen

• Doubt about the backing. If holders suspect the reserves or collateral are smaller, riskier or harder to reach than claimed, they sell first and ask questions later.
• A rush for the exit. Even sound reserves take time to turn into cash. When many holders want out at once, the market price falls until buyers step in.
• Thin liquidity. A token with shallow markets can move sharply on one large sale, especially in a liquidity pool that becomes unbalanced.
• A broken mechanism. Designs that rely on incentives instead of assets can stop working once confidence goes, and the decline feeds on itself.
• Bad prices. An oracle that reports a wrong price can trigger liquidations that push the market further.

Three cases worth knowing

TerraUSD (UST) was an algorithmic stablecoin held up by a second token rather than by reserves. In May 2022 large withdrawals broke the mechanism, and within days UST traded at a small fraction of a dollar. It never recovered.

USDC fell to about 87 cents in March 2023 after part of its reserves was caught in a US bank failure. Within days the reserves were confirmed reachable and the price returned to one dollar. The token was sound; for a weekend, nobody could be sure.

Smaller dollar tokens have depegged after hacks of the protocols that issued them, when attackers created tokens without collateral and sold them into thin markets. There the price fell because the backing really had been diluted.

How a depeg plays out

Picture a dollar token trading at 97 cents. If traders trust the backing, they buy it, expecting it to return to a dollar, and their buying pulls the price back. If they do not, nobody steps in, more holders sell and the price falls further. Lending markets that accept the token as collateral may liquidate positions, adding more selling. Whether a depeg recovers depends mostly on one thing: whether the assets behind the token are real and reachable.

Risks and limits

No design makes a depeg impossible. Reserves can be sound and the price can still dip in a panic, and a token can trade at one dollar right up to the moment a hidden problem surfaces. A short dip is not proof of failure, and a steady price is not proof of safety. What helps is evidence: frequent, independent proof of reserves, deep liquidity across several venues, collateral that does not depend on a single institution, and a clear public account of how the token holds its value.