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Depegging Events in Fiat and Crypto

The crypto community was rocked in mid-May with the news of the UST depegging. This event and the ensuing market crash made many in the community question the stability of some projects on the market.

May 31, 2022
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Executive Summary

At the time of writing, the cryptocurrency community is facing uncertain territory in the aftermath of the depegging of a major stablecoin, namely Terra’s UST.

Originally, we had intended this article to focus on the comparatively benign stablecoin depegging events that have occurred in the past, such as the event that occurred recently on USDN. However, the sudden UST depeg has made this topic all the more relevant and important, so we endeavour to give some context on events that are currently unfolding.

Many seemed surprised to learn that a stablecoin peg break could happen at all — there seemed to be an assumption in some sections of the crypto community that pegging one currency to another was a simple matter of hardcoding the value from an oracle of some kind, and therefore reasonably risk-free. As the present crisis is revealing, currency pegs are not that simple. However, neither are they unique to the cryptocurrency world, with fiat currencies experiencing peg breaks of their own in the past.

In this report, we shed some light on currency pegs in order to give the community some clarity on how they work, and how they can go wrong under adverse market conditions. To illustrate this more clearly, we touch on a famous example of a depegging event in the fiat currency world, namely the depegging of the Thai Baht during the 1997 Asian Financial Crisis, before showing how the same thing can occur in the crypto world. We hope that this will put the events of recent days and weeks into perspective and shed some light on the risks involved with currency pegs.

Here are the key takeaways from the report:

  • Stablecoin depegging has recently grabbed headlines in the media, with Terra Stablecoin UST spectacularly losing its peg in mid-May 2022.

  • Depegging events are common to both fiat and crypto. The loss of the Thai Baht’s USD peg in 1997 is a classic example of how this can occur.

  • The Luna Foundation Guard’s (LFG) average ratio of reserves to TVL is estimated to have been 0.12 leading up to the UST depegging. This may be compared to similar estimates of reserves to GDP for Thailand (0.18) and Indonesia (0.07) at the time of the 1997 financial crisis.

  • The LFG depleted its sizable Bitcoin reserves in an unsuccessful effort to defend the peg. Its BTC reserves appear to have dropped from 80,394 BTC on 7 May 2022 to just 313 BTC on 16 May.

  • Neutrino’s USDN has been another casualty of market turmoil, dropping its peg in both April and May of 2022, first as a result of market rumours and allegations about its structure and backing, and then as a result of contagion from the UST collapse.

  • Tether’s USDT lost its peg briefly on more than one occasion. During the market turmoil of 2018, it rose to $1.32 in July and dipped to $0.51 in October. However, it has so far always regained its peg, which is a positive sign for the overall viability of the concept.

  • Investors are encouraged overall to make sure they are aware of the risks involved with stablecoins, and not assume that all stablecoins are equal or carry an equal risk profile. 
  • Ultimately, the collapse of UST should be taken as a teachable moment for the industry.

Read the full report here: When the Peg Breaks: Depegging Events in Fiat and Crypto

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