Why do stablecoins lose their peg and how can you profit from it?

What is the Loss of Peg in Stablecoins?

The essence of stablecoins is that they should maintain a stable value, usually pegged to a fiat currency like the US dollar. However, stablecoins can lose their peg due to various factors.

For example, each stablecoin should have a reserve that ensures its stability. If USDT is worth $1, then the issuing company should have $1 in reserve to back this stablecoin. In recent years, crypto emitters and exchanges have started to conduct regular audits to confirm the proper backing of stablecoins, which usually confirms normal backing. 

However, there are cases where the peg is lost. For instance, financial difficulties or insufficient reserves can lead to a loss of peg. If the reserve backing the stablecoin is insufficient or if there is a significant financial issue, the stablecoin may lose its peg to the fiat currency it is supposed to track. 

Another reason for losing the peg can be technical issues. Smart contracts or algorithms that manage the stablecoin's peg can malfunction or be exploited, leading to a loss of peg. For example, the stablecoin UST, issued by the Terra project, lost its peg due to an algorithmic flaw that allowed for the excessive minting of new tokens, leading to a depeg. 

Examples of Peg Loss in Stablecoins

There are several notable examples of stablecoins losing their peg:

1. In May 2022, the stablecoin UST, issued by the Terra project, lost its peg to the U.S. dollar. This happened due to a discovered flaw in its algorithm, which speculators exploited to artificially lower its value. After losing its peg, both UST and its native token LUNA became virtually worthless;

2. In March 2023, two major stablecoins, USDC and DAI, experienced a temporary loss of peg due to the bankruptcy of three major U.S. banks where the reserves of these assets were held;

3. In October 2023, the stablecoin USDR from the Tangible project faced a loss of peg due to a sudden increase in redemption requests, leading to the depletion of the project's reserves.

How to Profit from Peg Loss in Stablecoins

While the loss of peg in stablecoins can be detrimental to their intended use, it can also present arbitrage opportunities. When a stablecoin loses its peg, its market value deviates from the value of the fiat currency it is supposed to track. This deviation creates opportunities for arbitrage, where traders can buy the stablecoin at a discount and sell it at a premium, profiting from the difference. 

For example, if a stablecoin that is supposed to be pegged to the US dollar loses its peg and trades at $0.95, traders can buy the stablecoin at this discounted price and sell it for $1 on another exchange where it is still trading at its pegged value. This arbitrage strategy allows traders to profit from the price discrepancy. 

ArbitrageScanner is a tool that helps traders identify these arbitrage opportunities by providing real-time notifications of peg loss events and potential profit margins. By using ArbitrageScanner, traders can quickly react to peg loss events and execute profitable arbitrage trades. 

Conclusion

The loss of peg in stablecoins can occur due to various factors, including financial difficulties, insufficient reserves, and technical issues. While this can be detrimental to the stablecoin's intended use, it also presents opportunities for arbitrage. Tools like ArbitrageScanner help traders identify and capitalize on these opportunities, allowing them to profit from the price discrepancies that arise from peg loss events.