How does a stablecoin peg work?
- Author
- CRYPTO PORT Editorial
- Published
- Updated
- Reading time
- 5 min
In short
A peg is the arrangement that ties a token's price to a target such as one US dollar. Nothing fixes the price by decree — it is held by arbitrageurs who profit whenever the market drifts from the target. Remove the conditions that make arbitrage profitable and the peg slips.
Key points
- Arbitrage, not any rule, is what holds the price at target
- Arbitrage needs minting and redemption to work smoothly
- Fees, minimum sizes and onboarding checks all impede it
- A peg is not a guarantee but a result of conditions being met
Definition
The whole set of arrangements that keep a stablecoin's market price near its target: arbitrage through minting and redemption, collateral liquidation, or supply adjustment.
With fiat-backed designs, when the market price sits below target an arbitrageur buys cheaply and redeems at face value with the issuer; when it sits above, they deposit cash, mint and sell. That round trip closes the gap, which is why frictionless minting and redemption is the peg's lifeline.
With crypto-backed designs, liquidation and the ability to withdraw collateral at the target price play the same role. Algorithmic designs use the swap into an absorbing token — but without collateral, the mechanism stops working the moment nobody wants the other side.
In every design the peg exists because someone profits from closing the gap. When redemption is slow or expensive, when it is open only to institutional counterparties, or when collateral cannot be sold, arbitrage stops paying and the price simply stays away from target.
Watch out for
- · A peg is not a price guarantee; it holds only while its conditions hold
- · Where individuals cannot redeem directly, arbitrage is left to institutions
- · On thin order books the price can sit far from target for a while