Synthetix’s sUSD depeg situation has once again highlighted the vulnerabilities within the DeFi system and the impact of liquidity changes.
Synthetix’s decentralized stablecoin sUSD has seen an unexpected turn of events after falling below its intended $1 peg. The stablecoin issued via the Synthetix DeFi protocol fell as low as $0.92 on Thursday before partially recovering to $0.96.
sUSD Depeg due to liquidity issues
The incident was initially confirmed by Chaos Labs, the risk manager for the Aave lending protocol. According to their analysis, the depeg was triggered when a major liquidity provider withdrew from the sBTC/wBTC liquidity pool on the Curve decentralized exchange. This provider redeemed sUSD through spot synth redemptions from Synthetix and then sold them on Curve, causing the value of sUSD to suddenly fall.
Synthetix, a platform that enables the creation of synthetic assets, or Synths, issues sUSD as loans overcollateralized with various crypto assets to maintain a 1:1 peg with the US dollar. However, recent activity has revealed weaknesses in this mechanism.
With the implementation of SIP-2059 in late April, spot synths other than sUSD will no longer be used on the Ethereum mainnet. This resulted in the end of atomic exchanges for other synths such as sETH and sBTC, forcing users to convert their synths to sUSD, which increased selling pressure on the stablecoin.
Meanwhile, this is not the first time a stablecoin has experienced a depeg due to liquidity issues. Last October, the real estate-backed stablecoin USDR fell to $0.53 per coin, albeit in a similar fashion. At the time, the team explained that liquid assets such as DAI were withdrawn from funds due to a surge in redemptions. Here’s part of the company’s statement on USDR depeg:
“Panic selling coupled with a shortage of DAI for redemption led to a depeg.”
Stablecoins are not ‘stable’
To maintain the meaning of its name, stablecoins are designed to always be worth $1 on the open market. However, in certain market conditions, you may sometimes lose your peg.
Circle’s USD Coin (USDC), one of the world’s largest cryptocurrencies by market capitalization, briefly fell to $0.885 per coin on March 11, 2023. It was a time when several banks in the United States went bankrupt. USDC regained the peg three days later, but Terra’s UST was not so lucky. UST lost its peg in May 2022 and never recovered. At the time of publication, each coin was worth $0.02219.
Synthetix’s sUSD depeg situation has once again highlighted the vulnerabilities within the DeFi system and the impact of liquidity changes. However, in the meantime, Chaos Labs recommended that the Aave community should temporarily freeze sUSD reserves in Aave V3 on the Optimism network. They argue the freeze will help mitigate further market impacts.
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