What Happens When a Stablecoin Breaks Its $1 Peg—and How It Recovers

The promise of a dollar that never changes

Imagine an app that lets you send dollars at any hour, almost anywhere, for less than a typical wire transfer. That's the idea behind a stablecoin—a digital token designed to hold a steady value of $1. It works like "cash on the blockchain" for people who want crypto speed without crypto mood swings.

The catch is that "stable" is a promise, not a law of physics. A stablecoin is only as solid as what backs it. Most dollar stablecoins are supposed to be backed one-to-one by reserve assets: cash, bank deposits, short-term government debt, or similar holdings. When the backing is solid and easy to reach, the coin tends to stay near $1. When it isn't, things break.

A depeg: when $1 stops meaning $1

A "peg" is the promised price. A "depeg" is losing it for long enough to matter. Tiny wobbles are normal—a busy afternoon can put a coin at $0.998 or $1.002 for a few minutes. That's just markets breathing. A real depeg is a deeper, longer gap.

Most serious depegs trace to one of six broad causes: reserve losses, bank runs, algorithmic failure, regulatory action, liquidity crises, or exchange-specific halts. At the center of almost every one is a reserve deficit—not always missing dollars, but backing that is suddenly inaccessible, illiquid, or worth less than people assumed.

Take March 2023. Silicon Valley Bank collapsed, and Circle, the issuer of USDC, disclosed that $3.3 billion of its reserves—roughly 8%—was sitting at that bank. The money wasn't gone, but it was locked up over a weekend when no redemptions could move. Within hours, USDC traded near $0.87. It recovered after U.S. officials guaranteed all SVB depositors. The lesson: even a "fully backed" coin can wobble when the backing can't be touched immediately.

Anatomy of a run: why everyone hurries

Stablecoins share a weakness with old-fashioned banks. They promise instant money but hold assets that can take time to sell. If many holders suddenly rush to redeem, the issuer may be forced to sell in a hurry. That creates a first-mover advantage: the first people out get full value, and latecomers may not. When people sense that, they run to be first.

In May 2022, panic from Terra's collapse briefly knocked Tether's USDT near $0.95. Its reserves did not vanish. But a wall of redemption requests threatened to overwhelm the redemption pipeline. Tether processed billions in redemptions, the queue cleared, and USDT returned near $1 within a day.

Compare that to TerraUSD itself. UST was algorithmic: no real dollar reserves. It relied on an automated dance with a sister token, LUNA, to keep its $1 price. When confidence cracked, the dance became a death spiral. LUNA's supply exploded and UST fell to fractions of a dollar, with combined losses above $40 billion. Real, usable backing was the difference between a scare and a wipeout.

Arbitrage: the invisible repair crew

So how does a peg normally come home? Through arbitrage: buying low in one market and selling high in another. Stablecoins have a two-level structure. A small group of institutional arbitrageurs can mint and redeem tokens directly with the issuer at $1. Everyone else trades on exchanges at floating prices.

When the exchange price drops below $1, arbitrageurs buy the cheap tokens, redeem them for $1, and pocket the difference. That buying pressure pushes the price back up. When the price rises above $1, they do the reverse: mint new tokens, sell them, and cool things down. Profitable for them, tidy for everyone else.

But arbitrage only works when redemption works. If reserves are trapped, queues are long, or assets can only be sold at a loss, the repair crew cannot close the gap. There's also a tradeoff: efficient arbitrage keeps prices pinned in calm times, but when reserves are illiquid it can also make it easier for well-connected traders to get out first during stress.

What makes a good reserve—and what makes a risky one

Under stress, speed matters more than book value. Cash and short-dated U.S. Treasury bills can be sold quickly with little loss. Commercial paper—short-term corporate debt—plus loans, crypto, and other exotics are slower and can shrink at the worst moment.

"Attestation" is not the same as "audit." An attestation is a point-in-time check by an accounting firm that, on a given date, reserve assets matched the coin supply. It doesn't show what happened the rest of the month, whether the custodian bank is healthy, or how strong the issuer's internal controls are. Useful photo; not live video.

Regulation is catching up. The U.S. GENIUS Act, signed in July 2025, requires payment stablecoin issuers to hold 1:1 reserves in cash, Federal Reserve deposits, or Treasury bills with 93 days or less to maturity. It bans "rehypothecation"—reusing the same reserve assets—requires segregated custody, monthly reports certified by executives and checked by an independent accounting firm, and gives coin holders first claim on reserves in bankruptcy. The EU, Japan, Singapore, and the UK have their own versions, with different rules on who can issue and what qualifies.

Laws still need implementation, and not everything labeled a stablecoin is covered. So it pays to look past the marketing: ask what backs the token, how often that backing is verified, who holds it, and what happens if you want your dollar back on a Sunday.

No "risk-free" label exists

Stablecoins are genuinely useful. They move fast across borders and power much of the crypto economy. But they are not bank deposits. There is no deposit insurance and no central-bank backstop. When reserves are real and redemption stays open, arbitrage usually brings a shaken coin home. When those two things fail, no software promise can save it.