Explanation
A peg holds through arbitrage: traders buy below parity and sell above it, as long as they trust that the collateral is redeemable.
How a peg holds
A peg works through arbitrage. If the coin drops to 0.99 euro, traders buy cheaply and redeem at the issuer for 1.00. If it rises to 1.01, they mint new coins at 1.00 and sell them higher. Both moves push the price back. That mechanism only works as long as redemption is credible and fast.
What breaks the peg
Three classic causes: the reserve proves less liquid than promised, the bank holding the reserve gets into trouble (as with USDC and Silicon Valley Bank in March 2023), or redemption is suspended. With algorithmic coins a loss of confidence alone suffices, since there is no hard reserve to fall back on.
Key takeaways
- Arbitrage sustains the peg.
- Fast redemption is the core of confidence.
- Bank risk on the reserve is real risk.
Frequently asked questions
+Is a peg a guarantee?
No, it is a promise plus a mechanism. Its quality depends entirely on the reserve and the issuer behind it.