A depeg occurs when a cryptocurrency that is designed to maintain a fixed value relative to another asset loses that price stability. The term is most commonly used in relation to stablecoins, which are typically pegged to fiat currencies such as the US dollar. A stablecoin is said to have depegged when its market price moves beyond the designated value range.
Stablecoins use cash reserves and short-term government bonds and algorithmic supply adjustments to maintain a constant price, which usually equals one dollar per token. A depeg can happen if backing reserves lose investor trust, large-scale redemptions take place, or market stress leads to destruction of liquidity. The token market price will experience short term movements that cause it to drop below its peg or increase above it.
Depegs can vary in severity. Minor fluctuations of a few cents are relatively common and may resolve quickly as arbitrage traders step in to restore balance. The more serious depeg situation leads to panic selling activities which create liquidity shortages that produce extensive market disruptions. The algorithmic stablecoin models, which depend on unbacked reserves, have experienced complete operational failures because they attempted to use prolonged depeg situations as their actual operational model.
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