De-Peg

A de-peg event occurs when a financial asset, whose value is supposed to be fixed to another asset, breaks away from that fixed price. Think of it as a promise of stability being suddenly broken. This “peg” is a fixed exchange rate, most commonly tying a country's currency to a more stable one like the US Dollar, or, in the modern digital world, tying a cryptocurrency “stablecoin” to a fiat currency. For example, a stablecoin might promise to always be worth exactly $1.00. A de-peg happens when market forces or a failure in its underlying mechanism cause its price to fall below—or sometimes shoot above—that target. This isn't a gentle drift; a de-peg is often a sudden, violent market event that can wipe out fortunes overnight, as it signals a complete loss of confidence in the asset's promised value.

Pegs are all about creating an island of stability in a sea of volatility. They are designed to make financial life easier and more predictable.

• In Traditional Finance: A country might peg its currency to a stronger one (like the US Dollar or the Euro) to control inflation, stabilize its economy, and encourage foreign trade and investment. For businesses operating between the two countries, a pegged exchange rate removes a major source of uncertainty. They don't have to worry about the value of their payments or receipts fluctuating wildly from one day to the next.
• In Cryptocurrency: The crypto market is notoriously volatile. The price of Bitcoin or Ethereum can swing dramatically in a single day. Stablecoins were created to solve this problem. By pegging their value to a stable asset like the dollar, they provide a safe haven for traders to park their funds without exiting the crypto ecosystem entirely. They act as a reliable unit of account and a bridge to the traditional financial world.

A peg is not magic; it must be actively defended. When the defense fails, so does the peg. The reasons for failure differ slightly between traditional currencies and their new digital cousins.

A currency peg is maintained by a country's central bank. The bank stands ready to buy or sell its own currency in the open market to keep the price at the pegged level. If its currency is weakening, it will buy it up using its foreign exchange reserves (e.g., its stash of US Dollars). A de-peg typically occurs when the central bank can no longer withstand the market pressure.

• Speculative Attack: If traders believe a currency is overvalued, they can borrow that currency and sell it, betting that the peg will break and the currency's value will fall. This forces the central bank to spend its reserves to defend the peg.
• Exhausted Reserves: If the selling pressure is too intense or lasts too long, the central bank may simply run out of the foreign currency needed to prop up its own. At this point, it has no choice but to abandon the peg. A famous example is when the Swiss National Bank unexpectedly de-pegged the Swiss Franc from the Euro in 2015, deciding the cost of defending the peg was too high.

Stablecoin de-pegs are a masterclass in risk. How they de-peg depends on how they were built.

• Fiat-Collateralized Stablecoins: These are the simplest type, supposedly backed 1-for-1 by hard assets like dollars in a bank. A de-peg can happen if investors lose faith that the reserves are actually there. If there are rumors of mismanagement or a lack of transparent audits, a “bank run” can occur where everyone tries to cash out at once. If the issuer can't meet the demand, the price will collapse.
• Algorithmic Stablecoins: This is where things get truly wild. These stablecoins aren't backed by real-world assets. Instead, they rely on a complex algorithm and a partner token to maintain their price. The most infamous example is the spectacular 2022 collapse of TerraUSD (UST). Its algorithm was designed to mint or burn a sister token, LUNA, to keep UST at $1. When massive selling pressure hit UST, the algorithm went into hyperdrive, minting trillions of LUNA tokens to try and prop up UST's price. This annihilated the value of LUNA, which in turn shattered all confidence in UST, triggering a “death spiral” that evaporated over $40 billion in a matter of days.

For a value investing practitioner, a de-peg event is not a trading opportunity; it's a profound lesson in risk management and fundamental analysis.

• The Illusion of Safety: De-pegs are a brutal reminder that “pegged” and “stable” do not mean “risk-free.” The risk is merely hidden, often building up silently until it explodes. A value investor is inherently skeptical of any investment that promises safety without a clear, understandable, and robust mechanism backing it up.
• Look Under the Hood: The key lesson is to always perform your due diligence. Don't take the “peg” at face value. Ask the hard questions. If it's a currency, what are the country's economic fundamentals? How large are its reserves? If it's a stablecoin, is it backed by audited, real-world cash, or by a complex, fragile algorithm you don't fully understand?
• The Importance of Your Circle of Competence: The collapse of algorithmic stablecoins perfectly illustrates Warren Buffett's principle of staying within your circle of competence. These assets operated on novel, highly complex, and untested code. A prudent investor who couldn't explain exactly how the peg was maintained would have wisely stayed away. A de-peg is often the market's final, brutal exam on whether an investor truly understood what they owned.