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Peg stability Meaning

Peg stability refers to the ability of a stablecoin to maintain its fixed value relative to another asset, most commonly the US Dollar. For a stablecoin like USDC or USDT, the peg is $1.00. Maintaining this peg is the single most important task for any stablecoin issuer, as any significant deviation, known as a de-peg, destroys the asset's utility as a medium of exchange and a safe haven for traders.There are three main mechanisms for maintaining peg stability.

Fiat-backed coins maintain stability by holding currency in a bank for every token issued, allowing for 1-to-1 redemption. Crypto-collateralized coins use over-collateralization and automated interest rates to incentivize users to mint or burn tokens to keep the price at $1. Algorithmic coins use complex supply-elasticity rules to expand or contract the token supply based on market demand.Stability is often maintained by arbitrageurs.

If the price of a stablecoin drops to $0.99 on an exchange, an arbitrageur will buy it for $0.99 and redeem it with the issuer for $1.00, pocketing a profit. This buying pressure pushes the price back up.

Conversely, if the price goes to $1.01, users will mint new tokens for $1.00 and sell them for $1.01, pushing the price back down. This incentive loop is what keeps the peg tight during normal market conditions.When peg stability fails, it is usually due to a bank run or a collateral crisis.

The most famous example is the collapse of UST (Terra), where the algorithmic peg failed and the selling wiped out billions in value. For fiat-backed coins, reserve transparency is the key to stability.

If the market doubts that the issuer actually has the dollars in the bank, the peg will begin to wobble. This is why regular audits and attestations are a critical component of stablecoin governance.

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