Be it buying or trading crypto or any financial instrument, such as equity or commodities, knowing the right price helps maximize returns. Besides, knowing the correct value helps make rational decisions. In short, pegging is a vital concept that helps determine the right value for any instrument.
Definition of pegged crypto
There are two ways to look at a peg. From a traditional currency perspective, a peg refers to an exchange rate like the USD-INR, USD-EUR, SGD-AUD, etc. Until several decades ago, gold was used as a benchmark to evaluate currencies. Until the 1930s, coins, bars, and gold jewelry provided the promise of a direct exchange to currency for the exchange of goods and services. But countries such as Britain and USA stopped accepting gold, and soon, the gold standard was out of fashion worldwide. Today, the US dollar is a global reserve currency. The conversion of one currency to another is a peg.
Peg can also refer to the Price to Earnings to Growth ratio, a crucial assessment tool in the equities market. Peg is also useful while evaluating an investment decision in stablecoins. To many investors, the price-to-earnings ratio and earnings per share have been the standard tools for assessing a stock’s performance—a lower PEG indicates better value. In the crypto world, PEG denotes the value of a particular crypto asset with external factors such as fiat money or other collateral such as gold, silver, or other stocks and instruments.
How does a currency peg work?
Generally, countries adopt either a fixed or a floating currency, mostly basing their decision on market fluctuations. A fixed-rate mechanism involves a government affixing value to its country’s currency. It is also likely that countries that adopt a fixed-rate mechanism may affix a price on a handful of currencies. Kuwait, Libya, Fiji, and Morocco follow a fixed-rate mechanism. Conversely, market conditions and economic parameters drive a floating currency.
Advantages of a currency peg
Pegging has several advantages, both for governments and businesses. To governments, a currency peg ensures stable planning, supporting exports, and maintaining an adequate supply of its currency to meet the market demand. Zimbabwe, for example, pegged its currency to the US dollar for several decades. In this case, the country could rely on a more stable US monetary policy, thereby avoiding demand issues in the domestic economy. A floating currency could be a disadvantage for businesses that largely rely on international markets to export their finished goods and import raw materials. Currency volatility makes calculating profits and margins a tall task. A stable currency is easier to track.
Disadvantages of a currency peg
One of the major disadvantages of pegging is the increased influence of foreign nations in domestic economic and political decisions. A currency peg will likely lead to trade inequalities, specifically the trade balance between two nations. A case in point is the Sino-US trade deficit, which has been the result of a peg between the yuan and the dollar.
Pegged crypto: Pros and Cons
Pegging in currencies is common in the crypto world as well. For instance, we all know that Bitcoin is the world’s most popular crypto asset, but it is also prone to significant volatility. A pegged crypto can eliminate several challenges, such as volatility and supply. Moreover, an average investor can easily evaluate such pegged digital currencies as their value is based on the value of an established asset, such as gold, the US dollar, crude oil, energy index, or even treasury bonds. The best example of a pegged currency in crypto is USD Tether (USDT).
Pros
Stablecoins are cryptos that are usually pegged to an existing asset. There are multiple benefits to investing in stablecoins from the perspective of an investor or trader keen on portfolio maximization. The first obvious benefit is the ease of tracking volatility. To any novice crypto investor, the pricing of popular flavors such as Bitcoin could be baffling and difficult to time. A minor error in trade could lead to a significant loss. Since a stablecoin is tethered to an asset, the intrinsic value of the asset is driven by market conditions that can be timed or analyzed for better profit maximization. Besides genuine advantages to early traders, stablecoins are designed to transfer fiat currency quickly and at less cost than a traditional cross-border transfer. Stablecoins help businesses transfer money with the least volatility, improve security, reduce financial transaction costs, and provide a hedge against inflation.
Cons
Yes, the benefits of stablecoins appear lucrative to many young adults, but they come with some downsides. Stablecoins are blockchain-based, and we all know of the one major benefit of such technology—decentralization. By fixing the peg in favor of another financial instrument, stablecoins give a more centralized structure. For example, a crypto instrument that is based on the value of gold is likely to be affected by gold miners, policy actions of the US Federal Reserve, and market demand. Besides, with excessive centralization, there is a lack of transparency associated with such crypto instruments.
Examples of currency peg
Believe it or not, several organizations and countries offer a crypto version based on some currency. According to verifiable sources, BitUSD, released in July 2014, was the first crypto asset based on the US dollar. Tether, which was released in 2015, is another example of a crypto instrument that is pegged to a fiat currency. Other popular examples of crypto pegs include True USD, Binance USD, and USD Coin. Commodities such as gold (PAXG), silver (SLVT), platinum (Platinum Coin), or crude oil (OilCoin) also back cryptos.
Conclusion
Pegged crypto flavors or stablecoins have been around for some time. Such crypto flavors are backed by real-world assets and provide transparency to common people, businesses, and governments. You can easily track and evaluate a pegged asset.
Stablecoins are also advantageous in cross-border payment mechanisms and quick remittances and act as hedge against inflation. Moreover, such crypto assets could also help improve the adoption rate among the largely unbanked or even non-crypto users. Stablecoins and pegged crypto investment avenues are thus enabling the global financial and payments system.
FAQs
What is a peg in trade?
In the crypto world, pegging refers to how the market assesses the value of a crypto asset with that of a real-world asset of value. For example, the value of a USD Tether with that of the US dollar. Pegging helps estimate the real value of a currency by comparing it against available collateral. Pegs help investors steer clear of the risk of crypto volatility.
How is peg calculated?
Crypto assets promoting pegs are called stablecoins and are expected to maintain collaterals to meet liquidity risks. For example, a 1:1 ratio in the case of the US dollar. In the unfortunate event that a stablecoin gets de-pegged or loses its value, it will drop below the underlying asset’s value. For example, BitUSD, the world’s first dollar-backed stablecoin, saw price trading to 80% of the US dollar or a ratio of 0.8:1.
Which peg ratio is best?
Pegs within stablecoins and pegged cryptos are generally earmarked at 1:1 and are considered safe instruments. However, during volatile sessions, this ratio is bound to change and thereby induce losses for a trader or investor.
How does a crypto lose its peg?
A cryptocurrency can lose its peg, typically in stablecoins, when it fails to maintain a 1:1 value with the asset it’s pegged to (e.g., USD). Factors like insufficient reserves, market fluctuations, or lack of trust can lead to a loss of peg.
What is peg and Depeg in cryptocurrency?
In cryptocurrency, “peg” refers to tying a cryptocurrency’s value to that of a stable asset (e.g., a fiat currency). “Depeg” is when it detaches from the fixed value, allowing its price to fluctuate freely.
What is soft peg vs hard peg crypto?
Soft peg allows cryptocurrency to fluctuate slightly around the pegged value, with interventions if deviating. Hard peg maintains a fixed value.
What is the safest pegged crypto?
As of my last update in September 2021, stablecoins like USDC, USDT, and DAI were considered relatively safe due to regulatory compliance and transparency. However, crypto markets are volatile; do thorough research and assess current conditions.
