Key Takeaways
- Stablecoins are approaching a $300-billion market cap, yet real-world adoption remains constrained due to persistent issues surrounding depegging, collateral quality, and investor trust.
- The depegging of stablecoins such as NuBits (2018), TerraUSD (2022), and USDC (2023) revealed fundamental weaknesses in both algorithmic and fiat-backed models.
- TerraUSD’s collapse wiped out approximately $50 billion in value, exposing the structural fragility of algorithmic systems.
- In 2025, Yala’s Bitcoin-backed YU lost its peg following an exploit, underscoring the ongoing problems of thin liquidity and cross-chain vulnerabilities.
Introduction
Stablecoins recently achieved a milestone with a combined market capitalization exceeding $300 billion. As of October 6, 2025, data from CoinMarketCap shows the total at around $312 billion.
However, despite this remarkable growth, stablecoins have yet to gain full mainstream acceptance. The main barrier is their recurring instability. Many stablecoins have lost their peg to the assets that supposedly back them—whether those assets are fiat currencies like the US dollar, commodities such as gold, or even other cryptocurrencies.
This article explores real-world examples of depegging events, examines why these failures occur, highlights the associated risks, and outlines what issuers and investors can do to reduce exposure.
Historical Overview of Stablecoin Depeggings
The history of stablecoins is punctuated by repeated depegging incidents that reveal weaknesses in both design and governance. One of the earliest notable failures occurred in 2018, when NuBits collapsed, demonstrating how unstable unbacked algorithmic models can be.
Even Tether’s USDt (USDT) briefly fell below $1 in 2018 and again in 2022, both times triggered by liquidity shortages and investor panic. These dips fueled long-standing concerns over the transparency and adequacy of its reserves.
The most devastating example came in May 2022, when the algorithmic stablecoin TerraUSD collapsed. Massive redemptions created a self-reinforcing spiral that drove its sister token, LUNA, into hyperinflation. The result was a catastrophic $50-billion loss in market value and widespread disruption across the crypto ecosystem.
Fiat-backed stablecoins have also proven vulnerable. USDT plunged to $0.80 in 2018 amid solvency fears, while USDC (USDC $1) lost its peg in 2023 following the collapse of Silicon Valley Bank. That event revealed how traditional banking risks can spill into the digital asset world. Dai (DAI $1) and Frax (FRAX $2.12), both partially backed by USDC, also briefly depegged during that time, underscoring how interlinked reserve structures can amplify market instability.
Together, these episodes highlight an ecosystem plagued by liquidity shortages, trust erosion, and systemic fragility, even as the sector edges closer to a $300-billion valuation.
Case Study: The TerraUSD Collapse
The May 2022 breakdown of TerraUSD (UST) marked a defining moment in the crypto industry. Unlike fiat-backed stablecoins, UST attempted to maintain its $1 peg through an arbitrage mechanism linked to its sister token, LUNA.
Its rapid rise in popularity was largely driven by the Anchor protocol, which offered depositors unsustainably high yields of nearly 20%. As doubts mounted and the broader crypto market weakened, confidence eroded rapidly. The first signs of trouble appeared on May 7, 2022, when two major wallets withdrew about 375 million UST from Anchor.
This triggered a wave of conversions from UST to LUNA. Within three days, LUNA’s circulating supply exploded from roughly 1 billion to almost 6 trillion tokens, while its price collapsed from about $80 to near zero. UST’s peg was shattered, and its design flaws became impossible to ignore.
The collapse exposed several weaknesses in decentralized finance (DeFi), including overreliance on speculative yield incentives and the lack of real-time transparency. Retail investors, often slower to react, absorbed the heaviest losses.
Case Study: Yala’s YU Stablecoin
In September 2025, Yala’s Bitcoin-backed stablecoin, YU, suffered a major depegging event after a cross-chain exploit. Blockchain analytics firm Lookonchain reported that an attacker minted 120 million YU tokens on the Polygon network and sold 7.71 million YU for 7.7 million USDC across the Ethereum and Solana networks.
By September 14, 2025, the attacker had converted these funds into 1,501 ETH and dispersed them across multiple wallets. They still held 22.29 million YU on Ethereum and Solana, with another 90 million remaining unbridged on Polygon.
The Yala team confirmed that all Bitcoin (BTC $121,773) collateral was secure, but the stablecoin still struggled to regain its peg. In response, Yala disabled its Convert and Bridge functions and launched a full investigation with security partners.
The incident revealed the structural weakness of thin liquidity. Despite a $119-million market capitalization, YU had shallow on-chain liquidity, leaving it highly vulnerable to exploitation. By September 18, 2025, the token had finally regained its peg, according to DEXScreener data.
Why Stablecoins Lose Their $1 Peg
Stablecoins are engineered to maintain consistent value, but real-world data shows that even the most sophisticated models can break under stress. The main causes of depegging include:
- Liquidity shortages: Shallow liquidity pools cannot handle large sell-offs, resulting in severe price drops. Yala’s Ether pool and Terra’s Curve imbalance both illustrated this vulnerability.
- Loss of trust and bank-run behavior: Confidence is the bedrock of stability. When trust erodes, panic-driven withdrawals create a downward spiral that amplifies volatility.
- Algorithmic flaws: Mint-burn models like Terra’s UST can fail catastrophically when redemption pressure overwhelms supply controls, exposing the limits of self-correcting mechanisms.
- External pressures: Broader market shocks, such as bank collapses, regulatory changes, or macroeconomic instability, can destabilize even well-collateralized stablecoins.
Risks Investors Cannot Ignore
Stablecoins promise predictability, yet history shows they carry significant risks that extend beyond price volatility.
- Financial losses: Depegging can erase billions in value. Unlike insured bank deposits, stablecoin holders face direct exposure to market collapse and counterparty risk.
- Security vulnerabilities: Exploits, such as Yala’s unauthorized token minting, demonstrate how smart contract weaknesses can rapidly drain liquidity and scatter funds across blockchains.
- Regulatory and reputational exposure: As the market approaches $300 billion, issuers like USDT, USDC, and USDe are under heightened scrutiny. Questions about transparency and risk management continue to slow mainstream adoption.
- Systemic contagion: The collapse of one stablecoin can destabilize others and disrupt the entire DeFi ecosystem. Terra’s failure, for instance, erased billions in wealth and triggered cascading liquidations across multiple platforms.
Conclusion
Repeated failures across both algorithmic and collateral-backed stablecoins have shown how fragile these assets can be. Liquidity gaps, inadequate collateralization, and weak governance remain persistent challenges.
To strengthen trust, issuers must prioritize robust collateral management using over-collateralized, liquid assets. Transparency should be non-negotiable—proof-of-reserves, third-party audits, and detailed reserve disclosures are essential. Emergency backstop funds can also provide a buffer against sudden sell-offs.
From a technical perspective, extensive smart contract audits, multi-signature protections, and minimized cross-chain exposure can reduce vulnerability. Regulatory frameworks such as the EU’s Markets in Crypto-Assets (MiCA) regulation and upcoming US stablecoin legislation will play a vital role in enforcing accountability. Insurance mechanisms and risk disclosures can further safeguard investors and bring stablecoins closer to the reliability they promise.
Frequently Asked Questions (FAQ)
What is a stablecoin?
A stablecoin is a cryptocurrency designed to maintain a fixed value, typically pegged to a fiat currency like the US dollar. Some are backed by reserves, while others rely on algorithms to control supply.
Why do stablecoins lose their peg?
They can lose their peg due to liquidity shortages, flawed algorithms, market panic, or external economic shocks. Loss of investor confidence often triggers rapid sell-offs.
What happened to TerraUSD (UST)?
TerraUSD’s algorithmic model collapsed in May 2022 after a massive redemption wave caused LUNA hyperinflation, destroying about $50 billion in market value.
How did Yala’s YU stablecoin fail?
In 2025, an attacker exploited Yala’s protocol to mint unauthorized tokens. Despite the Bitcoin collateral remaining safe, thin liquidity prevented the token from holding its peg until developers intervened.
Are fiat-backed stablecoins safer?
Fiat-backed models tend to be more resilient, but they are still exposed to risks such as bank failures or mismanagement of reserves, as shown during the 2023 USDC depeg.