Stablecoin Yield and Depeg Risk: The UST Lesson

Stablecoin yield is one of the most seductive and most misunderstood ways to earn on crypto, because the word “stable” makes it sound safe. It is not. A stablecoin can lose its peg — stop being worth the dollar it promises — and any yield paid on it carries all the normal lending risks on top. The most important lesson in the whole of earning interest on crypto came from a stablecoin: Terra’s UST, which paid around 19.5% and then collapsed to near zero. This is education, not financial advice.

What stablecoin yield actually is

Stablecoin yield is interest paid for lending out or depositing a dollar-pegged token, and it comes from the same handful of sources as any other crypto yield. A platform lends your stablecoins to borrowers who pay interest, deploys them in DeFi, or subsidises the rate with its own token to attract deposits. Because the token is meant to hold a steady $1 value, the yield feels like a bank rate with a bigger number. That feeling is the trap: the dollar peg is a promise made by an issuer or an algorithm, not a law of nature, and the yield is a separate risky activity layered on top.

What a depeg is

A depeg is when a stablecoin stops trading at its target value — usually $1 — and starts falling below it. Stablecoins hold their peg in different ways, and the way matters enormously. Some are backed by reserves of cash and short-term government debt held by an issuer; these can still depeg if the reserves are doubted, frozen or insufficient, but there is at least something behind them. Others are “algorithmic”, holding their peg through a mechanism that trades against a second, volatile token. Algorithmic designs have repeatedly failed, because the mechanism that is supposed to defend the peg can go into reverse under stress and accelerate the collapse instead.

The UST collapse, dated

Terra’s UST was an algorithmic stablecoin whose demand was driven largely by the Anchor Protocol paying around 19.5%. In early-to-mid May 2022 UST lost its peg; its design minted large amounts of the linked LUNA token to try to restore $1, which flooded the market and sent LUNA from roughly $80 to a fraction of a cent within days. About $50 billion of value evaporated, and the shock rippled into the leveraged funds and lenders that failed over the following weeks. Anyone who had parked “stable” dollars in UST to earn that 19.5% watched both the yield and the principal disappear almost at once. The wider chain of failures is in our 2022 crypto-lending collapse guide.

“Stable” describes an intention, not a guarantee. The higher the yield paid to hold a stablecoin, the harder you should look at what is keeping it worth a dollar in the first place.

The two risks stack

With stablecoin yield you are exposed to two failures at once: the peg breaking, and the platform paying the yield failing. Either one can cost you. A high advertised rate on a stablecoin should make you more suspicious, not less, because — as covered in why high crypto yields are a red flag — a big number usually means the peg is being propped up by subsidy, or your coins are being lent somewhere risky, or both. The comfort of the word “stable” is doing marketing work that the underlying design may not support.

How to think about it if you hold stablecoins

If you hold stablecoins, treat the peg as something to scrutinise, not assume. Understand how a given stablecoin is backed and by whom, and be especially wary of algorithmic designs and of any offering a high, fixed yield simply for holding it. Remember that holding a stablecoin still means trusting an issuer or a mechanism — it is not the same as holding actual dollars in a bank — and that earning a yield on it adds a second layer of counterparty risk. The lower-risk position is to hold as little as you need, from the most transparent issuer you can find, and to be sceptical of any rate that makes “stable” sound too rewarding.

Regulation of stablecoins is still developing and differs by country, so the rules and protections that apply to a given coin can change. That uncertainty is one more reason to date what you know, check the current status, and avoid treating any stablecoin — however large — as a risk-free dollar.

Reserve-backed is not risk-free either

It would be comforting to conclude that algorithmic stablecoins are the only dangerous kind, but reserve-backed ones carry their own risks. A reserve-backed stablecoin is only as sound as the assets behind it and the honesty of the issuer holding them. If the reserves are not what is claimed, are held in riskier instruments than advertised, or are frozen by a bank or a regulator, the coin can wobble or break its peg even though nothing “algorithmic” failed. Reserve-backed coins have briefly lost their pegs during banking scares, recovering only once the backing was confirmed — which is reassuring in hindsight but terrifying in the moment, and offers no comfort at all to anyone who panic-sold at the bottom. The lesson is that “backed” is a claim to verify, not a guarantee, and that the entity holding the reserves is itself a counterparty you are trusting.

Layer a yield on top and you are now trusting three things at once: that the peg holds, that the issuer’s backing is real, and that whoever pays the yield can keep paying it without failing. Each is a separate point that can break independently, and a stress event in the market has a habit of straining all three together. This is why a stablecoin yield can feel calm for a long time and then unravel quickly — the risks are correlated, and they arrive together precisely when you would most want your “stable” dollars to behave like dollars.