Stablecoin Depeg Risk: What Actually Breaks

A stablecoin is a claim, not a currency

A stablecoin holds its value because something makes it redeemable near its target. That something differs by design, and the design is what determines the risk.

Type	Backing	Main risk
Fiat-backed	Cash and equivalents held by an issuer	Issuer solvency, reserve quality, regulatory seizure
Crypto-backed	Over-collateralised crypto in contracts	Collateral crash, liquidation failure, contract bug
Algorithmic	A mechanism rather than assets	Reflexive collapse — has happened catastrophically

What a depeg actually is

A depeg is the market price diverging from the target. Small deviations are routine and arbitrage usually closes them quickly. What matters is whether the mechanism that closes the gap is still functioning.

A stablecoin trading at 0.995 because of temporary imbalance is very different from one trading at 0.995 because redemption has been suspended — the price looks similar and the situation is not.

How depegs have happened

Algorithmic collapse. A large algorithmic stablecoin failed completely in 2022, wiping out tens of billions in days through a reflexive spiral between the stablecoin and its supporting token.
Reserve exposure. A major fiat-backed stablecoin briefly depegged in 2023 when part of its reserves sat at a bank that failed, resolving once deposits were guaranteed.
Liquidity stress. Stablecoins have traded below target during market panics when redemption capacity could not match selling.

The pattern worth noting: the failure that was total was the one with no assets behind it. The ones that recovered had real reserves and a redemption mechanism that resumed working.

What to check

What backs it, specifically. Cash and short-term government securities is a different proposition from commercial paper or crypto collateral.
Who attests to the reserves, and how often. An attestation is not a full audit; the distinction matters.
Whether you can actually redeem. Many issuers permit direct redemption only for large institutional holders, which means retail depends on market liquidity instead.
Regulatory status of the issuer and where it operates.
Concentration. Holding one stablecoin exclusively concentrates a risk that is cheap to diversify.

For Indian holders

Stablecoins are virtual digital assets. A disposal — including swapping one stablecoin for another, or spending one — is a transfer taxable under Section 115BBH, and 1% TDS applies.

This is easy to overlook precisely because stablecoins feel like cash. Moving between USDT and USDC is a taxable transfer in India even though the value did not change, and the record-keeping obligation applies the same way.

Why algorithmic designs fail the way they do

An algorithmic stablecoin maintains its peg through a mechanism — typically minting and burning a companion token — rather than through assets. The mechanism works while confidence holds and inverts when it does not.

The failure is reflexive: as the stablecoin falls below peg, the mechanism issues more of the companion token, diluting it, which reduces the value supporting the peg, which pushes the stablecoin further down. Each step accelerates the next. This is not a flaw in one implementation but a property of the design, which is why the collapses have been so total and so fast.

Holding stablecoins is not holding cash

The most useful mental correction: a stablecoin is a claim on an issuer or a mechanism, not a deposit. There is no deposit insurance, no central bank backstop, and generally no retail redemption right.

That does not make them unusable — they are genuinely useful — but it means a stablecoin balance carries credit risk that a bank balance does not, and a large balance held for a long period deserves the same scrutiny you would apply to lending the money to a company.

Practical handling

Split large balances across more than one issuer.
Prefer issuers publishing frequent, detailed reserve reporting.
Keep long-term savings in a bank rather than a stablecoin, unless there is a specific reason not to.
Watch for redemption suspensions, which are a more serious signal than a small price deviation.
Remember network choice when transferring — sending to the wrong chain is the most common way stablecoins are actually lost.

Depegs upward happen too

A stablecoin can trade above its target, usually when demand to acquire it exceeds the capacity to mint new supply quickly, or when access to redemption is restricted in a particular market. This is less dangerous than a downward depeg but still a signal that the arbitrage mechanism is not working freely.

Either direction indicates the same underlying thing: something is impeding the process that normally holds the price at target. That is what deserves attention, rather than the direction of the deviation itself.