In this article, you will learn what is the definition of pegged cryptocurrency. Pegging means the linking of the value of an asset or a currency to the value of another asset or currency. Now, in the DeFi space and blockchain systems, pegged cryptocurrencies are becoming increasingly popular.
What is the Definition of Pegged Cryptocurrency?
A pegged cryptocurrency is a cryptocurrency whose value is linked to a specific bank-issued currency, financial instrument or tradable commodity. Since the bank-issued currency -- U.S. dollar (USD), British pound (GBP), euro (EUR), etc. -- is fiat currency, a pegged cryptocurrency is also known as a fiat-pegged cryptocurrency.
Regardless of which fiat currency or commodity it is linked to, the pegged cryptocurrency is an encryption-secured digital medium of exchange. The link or peg is determined by the exchange rate between the two currencies. Once this exchange rate is established -- usually, one to one -- the value of the cryptocurrency fluctuates in the same direction and to the same degree as the fiat currency to which it is pegged.
Pegging a cryptocurrency to fiat currency brings stability to the pegged coin or token in an otherwise volatile crypto space. The last couple of years are a great example of volatility in the crypto market. Bitcoin reached an all-time high (around $69.000) in 2021. and the price of Bitcoin at the time of writing this piece hovers around $16.700.
Crypto pegging creates a stable environment for a cryptocurrency and safeguards investors from broad and rapid fluctuations. This is why pegged cryptocurrencies are also called ‘stablecoins.’
How Does Pegged Cryptocurrency Work?
Pegged cryptocurrency 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.
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.
Bottom Line
There are both advantages and disadvantages of pegged cryptocurrencies and the choice would be up to your preferences. This is about what is the definition of pegged cryptocurrency.
