A stablecoin depeg is an issue plaguing the crypto industry, but not many people have substantial knowledge of how it affects stablecoins.
There have been many scenarios where there was a stablecoin collapse, and the effects are usually deadly. Continue reading as we provide credible insights into the meaning of stablecoin depeg, its effects, and its benefits.
What is Depegging?
Before understanding depegging meaning, you must first have a good knowledge of what stablecoin is. Stablecoins are cryptocurrencies that function as the fiat of the industry. In other words, they act like the US dollar, Euros, and Pounds and help traders make transactions.
Although there are many stablecoins available, not all of them are considered safe for trading or investing. Despite the numerous transactions and new projects that emerge in the crypto world, traders tend to stick with only a few of the best stablecoins for their trades.
However, these stablecoins must be first pegged to these fiat currencies to function this way. Pegging a stablecoin means making them maintain the same value as the fiat it represents.
For instance, assuming a stablecoin represents the US dollar, it must maintain the same value. This means there must always be a 1:1 comparison between the two.
When a stablecoin fails to maintain a 1:1 value with the fiat it represents, it is called a stablecoin depeg. For example, if a stablecoin is pegged to the US dollar, 1 stablecoin should represent 1 dollar.
However, if the stablecoin depegs, 1 stablecoin will be worth less than $1, such as $0.80 or lower. This has happened many times to very popular stablecoin projects.
Stablecoin depegging occurs for various reasons and can negatively impact the stablecoin. One of the reasons for this is liquidity issues. If a stablecoin is in high demand in the cryptocurrency market but lacks enough liquidity to meet the demand, it can lead to depegging of the stablecoin.
But this isn't all; many other factors can lead to a stablecoin depeg, including technical issues such as smart contract bugs, regulatory issues like SEC lawsuits, and market conditions. In the past, we have seen many stablecoins depeg such as the Terra Usd crash and the USDC.
Risks/Consequences of a Stablecoin Crash
Below are some negative impacts, assuming there's a stablecoin crash.
Negative Impact on Investors
As previously stated, stablecoins provide the same benefits as fiat currency. They allow crypto traders and investors to store their assets and income.
Therefore, a stablecoin crash can result in a significant devaluation of their holdings and earnings. For example, if a crypto investor has $100,000 invested in a stablecoin and it devalues to $0.80, their assets would decrease to approximately $80,000.
When there's a stablecoin depeg, many investors and traders will be confused about whether to sell off their holdings or leave them. A trading crossroads like this in the crypto industry isn't good, as it can negatively impact liquidity.
Brings Negative Reputation to the Crypto Industry
Another negative impact of stablecoin is that it leads to doubts and disappointment within and outside the crypto industry. They are called stablecoins because they are perceived to be more stable than other classes of cryptocurrencies.
So, if there's a depeg, those who believe this will start having doubts about it. For instance, in the case of the Terra Usd depeg, it made many people who once held an interest in the crypto industry lose interest. The depegging of stablecoins brings a bad name and perception of the crypto industry.
The Securities and Exchange Commission started being extremely apprehensive of the crypto industry with the occurrence of stablecoin depegs like Terra USD.
The function of federal agencies like the Securities and Exchange Commission is to protect investors. So, a depeg of a stablecoin puts many investors at a massive risk, which usually makes these regulatory bodies intervene. Sometimes, their intervention usually leads to massive restrictions on the crypto industry.
Benefits Of Stablecoin Depeg
Even though a depegging event for a stablecoin is filled with many negative impacts, there are still some benefits for some traders. In fact, many traders made thousands of dollars in the wake of a stablecoin depeg using arbitrage trading. They buy from exchanges where this stablecoin is trading at a lower rate and sell where it is at a higher rate.
Depegging of a stablecoin can provide crucial insights for the issuers of this stablecoin on several factors and issues that made the stablecoin depeg.
As a crypto trader, you may not find stablecoin depegging to be beneficial. However, it is important to understand the true value of stablecoins.
Investors who wish to hold these stablecoins must conduct thorough research on the reserve of the stablecoin project they prefer. A stablecoin depeg may occur due to certain issues that can be quickly resolved, but in some cases, the possibility of reversal is overruled and value may be lost forever.