Why Do Stablecoins Depeg? The Mechanisms Behind Every Real Case
A closer look at the specific failure modes that have caused stablecoins to lose their peg, from reserve doubts to algorithmic death spirals.
By Firoz Khan|4 August 2026|Updated 1 October 2026|4 min read
A stablecoin depegs when its market price meaningfully diverges from its intended target, almost always $1 or £1. It's meant to be a rare, temporary anomaly quickly corrected by arbitrage. In practice, several real, well-documented depegging events have shown the mechanisms that are supposed to hold the peg can fail under specific, identifiable conditions.
Reserve doubt: the fiat-backed failure mode
A fiat-backed stablecoin's peg depends entirely on market confidence that redeemable reserves genuinely exist. When credible doubt emerges about an issuer's reserves or solvency, holders rush to redeem or sell, and if that rush outpaces the issuer's actual ability to honour redemptions, the price can trade meaningfully below the peg until confidence, and typically clearer reserve reporting, is restored.
A real example: USDC in March 2023
Silicon Valley Bank was closed by regulators on 9 March 2023. Circle, the issuer of the USDC stablecoin, then confirmed that $3.3 billion of its cash reserves, about 8% of the total, was held at the failed bank. On 11 March USDC traded as low as about 86 cents. On the evening of Sunday 12 March the US Treasury, the Federal Reserve and the FDIC announced measures to make sure banks could meet the needs of all their depositors, insured and uninsured. USDC recovered sharply and was back at $1 once Circle resumed redemptions on Monday 13 March.
Nothing had gone wrong with USDC's design. Doubt about part of the reserve was enough. For a holder, a fall to 86 cents is a 14% loss in value, before any move in the pound against the dollar.
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Collateral shock: the crypto-backed failure mode
A crypto-collateralised stablecoin is backed by other volatile cryptoassets held in excess of the coin's issued value. A sudden, sharp fall in that collateral's value can push the system below its required collateralisation ratio faster than automated liquidations can correct it, straining the peg during exactly the market conditions when it's most needed to hold.
The algorithmic death spiral: the mechanism behind the biggest collapse
TerraUSD relied on a two-token mechanism where the stablecoin could always be swapped for a fixed dollar value of a companion token to maintain its peg, with no real collateral backing the promise. Once confidence cracked and large-scale selling began in May 2022, that swap mechanism itself flooded the market with the companion token, collapsing its price and destroying the very mechanism meant to restore the peg, a self-reinforcing spiral that wiped out tens of billions of dollars in value within days.
What this means for evaluating any stablecoin today
Check specifically which mechanism backs the peg, and stress-test it mentally: what actually happens to this specific coin during a genuine crisis of confidence, not just during calm, normal market conditions. The mechanism, not the branding or the word 'stable' itself, is what determines how it behaves under real pressure.
A simple stress test
Ask three questions of any stablecoin. What exactly backs it, and where is that held? Who can redeem it for currency, and how quickly? And what happens if part of the backing loses 10% of its value overnight? If you cannot answer the first two from the issuer's own published information, treat the peg as a promise you cannot check.
The UK angle
UK stablecoin rules are being built but the FCA says the new regime starts on 25 October 2027, and until then most stablecoins are effectively unregulated for UK holders. The FCA says crypto is largely unregulated in the UK and that it is highly unlikely you would be covered by the Financial Services Compensation Scheme. Most large stablecoins also track the dollar, so a UK holder can lose value from the exchange rate even when the peg holds.
A reminder
The FCA risk warning still applies to higher-risk crypto content. Always assess how much risk you are willing to take before buying.
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