What Is Pegged Cryptocurrency? How It Works

The crypto ecosystem breeds volatility. In attempts to maintain some sort of stability in this market, pegged cryptocurrencies were created. Read on to learn more about these digital assets and how they work.

What Is Pegged Cryptocurrency? How It Works

Disclaimer: This is for informational purposes and is not meant to serve as financial or investing advice.

What Is a Pegged Cryptocurrency?

Pegged cryptocurrency is a digital currency hinged to a fiat currency, financial instrument, or tradable commodity.

Many times, pegged cryptocurrency is backed by fiat currency, a fancy word for currencies supported by a central bank, like U.S. dollars (USD), British pound (GBP), and euro (EUR).

The word “peg” is defined as a specified price for the exchange rate between two assets. In this case, pegged cryptocurrency refers to the price the digital asset token aims to stay at.

Once the exchange rate is established, the value of the cryptocurrency will fluctuate in the same direction as the fiat currency to which it is pegged.

How Does Pegging Crypto Work?

Pegged crypto maintains its peg through smart contracts or diluting the total supply. The changes in the token supply will change the relative price of each token until it reaches a desired peg value.

For example, USDT, DAI, and FRAX are pegged to $1. The dollar itself is pegged to the consumer price index (CPI), which tracks a collection of goods in the current economy.

Regardless of which fiat-backed currency or commodity a cryptocurrency is pegged to, it is considered an encryption-secure digital medium of exchange.

Are Pegged Cryptocurrencies a Type of Stablecoin?

The majority of the time, pegged cryptocurrencies refer to stablecoins.

Stablecoins are crypto assets that maintain a 1:1 value with its pegged value over a long period.

The nature of stablecoins desire to minimize volatility and fluctuations in the crypto market. In other words, stablecoins are designed to remain stable, unlike the most popular cryptocurrencies like Bitcoin (BTC) and Ethereum (ETH), which have been victims of the drastic volatility rates over the past year.

Trades can occur at the market price of a stablecoin which may differ from the pegged price, but the goal of pegging is to keep the two prices as aligned as possible.

Most pegged cryptocurrencies are pegged to U.S. dollars (USD) because it is the dominant currency in the international financial sector and one of the most stable fiat currencies in the world.

Another popular commodity that pegged cryptos is backed by is gold, which is relatively stable. This steadiness is imperative if cryptocurrency desires to serve as an instrument of exchange for real-world transactions rather than solely digital transactions.

Is Pegged Crypto Different From Backed Crypto?

The short answer is yes; they can be different. Pegging cryptocurrencies can be achieved in two different ways.

  1. Reserve or back the coin, where a tangible asset supports each cryptocurrency.
    These cryptos or backed stablecoins can be hinged on dollar currencies, gold, and real estate. When the prices of these cryptocurrencies are associated with physical assets, they are less likely to be as volatile as regular cryptocurrencies. Being backed by physical assets also help to define the mechanics that influence cryptocurrency price swings.
  2. Algorithmically, where any tangible assets do not back these cryptocurrencies. For algorithmic stablecoins, a smart contract made up of a particular algorithm keeps prices stable.

What Are the Advantages of Pegged Crypto?

The cryptocurrency market is notorious for its volatility due to various factors such as marketplace risk, supply and demand, investor sentiment, media reports, and government regulations.

This volatility causes the price of digital assets to fluctuate by thousands of dollars at a time quickly. Because of this, pegging cryptocurrencies have some notable advantages.

Pegging a cryptocurrency to a more stable fiat currency or commodity can:

  • Protect from extreme levels of volatility.
  • Minimize significant changes in market prices.
  • Produce more liquidity.
  • Maintain stability over a long period.
  • Low fees.
  • Secure transactions.
  • Regulated processes.

What Are the Disadvantages of Pegged Crypto?

There are a few disadvantages of pegged cryptocurrencies which are:

  • There can be less of a return on investment due to the lack of volatility.
  • Requires a third party to be validated.
  • Requires trust from an entity, like a central bank.
  • Government regulation.
  • The fiat-involving process involved.

For all the reasons above, many investors and crypto enthusiasts may shy away from investing in pegged cryptocurrencies. In most cases, a cryptocurrency market is a breeding place for risk-takers and those who know how to navigate a volatile market and make loads of money.

If you are looking to play the volatility game and ride the fluctuation wave to make large profits, there are better ways to go than stablecoins.

What Are Some Examples of Pegged Crypto?

Tether (USDT)

Tether (USDT) is a cryptocurrency stablecoin pegged to the U.S. dollar and backed by reserves. It is considered the largest stablecoin with a market capitalization of $83 billion. It is the third-largest cryptocurrency after Bitcoin (BTC) and Ether (ETH).

Tether was initially based on the Bitcoin blockchain and now supports Ethereum, TRON, EOS, Alogrand, Solana, OMG Network, and Bitcoin Cash blockchains.

USD Coin (USDC)

USD Coin (USDC) is a cryptocurrency stablecoin fully backed b U.S. dollar assets. USDC is a tokenized U.S. dollar valued at a pegged 1:1 ratio of USD coin to the value of one U.S. dollar.

This stablecoin’s reserved assets are regulated and held in accounts with U.S. financial institutions, but the U.S. government is not the issuer. USDC is an open-source project, meaning anyone in the general public can view and contribute to the project's blockchain.

USDC is compatible with Ethereum, Algorand, Solana, Stellar, and TRON blockchains.

Euro Coin (EUROC)

Euro Coin (EUROC) is a reasonably new euro stablecoin introduced in June 2022 and issued by Circle, the same issuer as USD Coin (USDC).

Circle states that EUROC is under the same full-reserve model as USD Coin and is 100% backed by the Euro with a 1:1 ratio. It is centralized and held in U.S. central bank accounts denominated in euros.

EUROC is based on the Ethereum blockchain and is supported by numerous exchanges such as Binance.US, Bitstamp, Huobi Global, and FTX.

The combination of EUROC and USDC can open up significant possibilities for the cryptocurrency ecosystem.

agEUR (AGEUR)

agEUR (AGEUR) is a cryptocurrency stablecoin of the Angle Protocol and is pegged to the Euro with a 1:1 ratio. This coin is backed by derivatives and by the insurance fund of the Angle Protocol.

This stablecoin functions on the Ethereum blockchain and is decentralized.

Digix Gold (DGX)

Digix Gold (DGX) is a unique stablecoin tied its value to 1 gram of gold.

Singapore-based DGX reserves its tokens against physical bars of gold, and these tokens' redemption is a bit complex and needs to be done in person.

How Do Pegged Cryptocurrencies Maintain Value?

As mentioned above, not all stablecoins use the same method to keep their value. Whether these cryptocurrencies are fiat-based, commodity-backed, crypto-backed, or algorithmically backed, these projects keep their value via a value-backing system. That is what makes them a pegged currency.

What Is an Algorithmic Stablecoin?

Algorithmic stablecoins operate on blockchains that contain smart contracts. These smart contracts consist of algorithms that are programmed to automatically respond to supply and demand fluctuations by either creating more coins or burning existing coins.

More tokens are created automatically when an algorithmic stablecoin trades above its pegged value, so prices fall. When these coins trade below their pegged value, tokens are then burned. Since there is a lower number in supply, the demand will go up, as will prices.

Unlike stablecoins that are backed by fiat currency and can be government-regulated, algorithmic stables are not supported by a tangle asset and therefore are unregulated and decentralized.

The Bottom Line

A peg in crypto means that specific cryptocurrencies are linked to a fiat currency, commodity, or algorithm. These currencies attempt to follow these pegged values and maintain the stability of prices. Stablecoins are a type of pegged crypto and are an investment option used to diversify financial portfolios and hedge against the cryptocurrency market's volatility.

For more information on investing and diversifying your portfolio, visit us today at Pluto.

Sources:

Peg | Alexandria | CoinMarketCap

Gold-Pegged vs. USD-Pegged Cryptocurrencies | Investopedia

What Is Pegged Cryptocurrency? - How to Use Them | LetsExchange

Tether (USDT): Meaning and Uses for Tethering Crypto Explained | Investopedia

USD Coin (USDC): Definition, How It Works in Currency, and Value | Investopedia

Euro Coin (EUROC) I A Euro-Backed Stablecoin | Circle.com

Angle Protocol | Angle.money