PSM (peg stability module)

PSM (Peg Stability Module)

A Peg Stability Module is a mechanism that helps a stablecoin hold its peg by allowing direct, near-1:1 swaps between that stablecoin and another reference asset, usually a second, highly trusted stablecoin. It acts as a built-in arbitrage backstop: whenever the stablecoin drifts from its peg, anyone can use the PSM to swap it for the reference asset at the fixed rate, and that swap pressure pushes the price back toward par.

The classic example is the PSM used by the Sky Protocol (formerly MakerDAO) for DAI, which lets users swap DAI for USDC (and back) at a fixed rate. If DAI trades below $1, arbitrageurs buy the cheap DAI and redeem it through the PSM for a full dollar of USDC, profiting from the gap and buying pressure lifts DAI back to peg. If DAI trades above $1, the reverse happens. The PSM effectively caps how far the peg can drift, as long as the reference asset itself holds.

The trade-off is that a PSM ties the stablecoin's stability to the reference asset it swaps against. A PSM backed heavily by one external stablecoin inherits that stablecoin's risk: if the reference asset loses its peg, the PSM transmits that shock rather than absorbing it.

Related: Stablecoins (USDC, USDT, DAI): how the peg actually holds.