What Actually Happens When a Stablecoin Depegs — and How It Gets Back to $1
A mechanical explainer of why stablecoins lose their dollar peg, using the 2023 USDC/Silicon Valley Bank episode, and how arbitrage restores it.
Photo: William Murphy from Dublin, Ireland · CC BY-SA 2.0 · source
A stablecoin is supposed to always be worth one dollar. When it isn’t, the mismatch — a “depeg” — reveals a lot about how these tokens are actually backed, and how the market pressure that fixes the problem works. The clearest recent example happened in March 2023, when USDC, one of the largest dollar-pegged stablecoins, briefly traded as low as 86 cents.
Why a “stable” coin can stop being stable
Fiat-backed stablecoins like USDC are designed to hold one dollar (or an equivalent asset) in reserve for every token in circulation, redeemable on demand. The peg depends entirely on the market trusting that redemption promise. According to CNBC’s reporting from March 2023, USDC issuer Circle disclosed that $3.3 billion of its cash reserves — about 8% of what backed the token — was held at Silicon Valley Bank, which had just been shut down by regulators. Once that news spread, traders questioned whether every token could really be redeemed for a full dollar, and some sold immediately rather than wait to find out, pushing the market price down.
More broadly, Chainlink’s explainer on depeg causes lists several triggers beyond banking exposure: liquidity crises where many holders try to redeem at once and overwhelm available reserves, technical exploits or oracle failures that corrupt the collateral backing a token, and contagion effects where forced liquidations elsewhere drain the liquidity pools that normally keep prices aligned. Each scenario has the same effect — the market price temporarily disconnects from the promised redemption value.
The arbitrage mechanism that pulls the price back
A depeg doesn’t just sit there; it creates a profit opportunity that market participants are incentivized to close. As Chainlink describes it, if a token is trading below its $1 target, institutional participants with direct redemption access can buy the discounted tokens on the open market and redeem each one with the issuer for a full dollar’s worth of the underlying asset, pocketing the difference. That buying pressure pushes the market price back up toward $1. The mechanism runs in reverse if a token trades above its peg: traders sell the token and buy the underlying asset instead.
This arbitrage only works, however, if buyers still believe redemption will actually happen at full value. During the USDC episode, that belief was in doubt for about 48 hours.
How the USDC peg was actually restored
Coverage from CoinDesk traces the recovery to a combination of factors rather than arbitrage alone. Circle publicly committed to covering any shortfall in reserves using its own corporate funds if the full $3.3 billion wasn’t recovered from the failed bank — a pledge meant to restore confidence in the redemption promise itself. Separately, federal regulators announced that all Silicon Valley Bank depositors, Circle included, would have full access to their funds starting the following Monday. Major exchanges, including Binance, which had briefly suspended USDC conversions, resumed trading over the weekend, restoring the liquidity arbitrageurs needed to act. By the time the FDIC confirmed deposit access on Monday, USDC had returned to its full dollar peg, according to data cited in that reporting.
What this reveals about stablecoin risk
The episode shows that a stablecoin’s peg is only as strong as confidence in its reserve backing and the operational ability to redeem it. Reserve composition, banking relationships, and issuer transparency all matter more during stress than they do in ordinary trading. It also shows that recovery isn’t guaranteed by market mechanics alone — TerraUSD, an algorithmic stablecoin that depegged in 2022, never recovered because its stabilization mechanism relied on a companion token whose value collapsed alongside it, removing any real backing to arbitrage against.
Takeaway: A stablecoin depeg is a signal that the market is pricing in redemption risk, not a fixed technical glitch — whether and how fast it re-pegs depends on the strength of the reserves behind it and the transparency of the issuer, factors that differ significantly from one stablecoin to another.
A peg holds on the same thing an exchange does — verifiable backing. See what a proof-of-reserves report actually proves (and doesn’t) and where crypto actually gets stolen from, based on 2026 incident data.