Pegged Currency Definition
Pegged currency is a term employed in the field of finance, more specifically in economics and cryptocurrency. It refers to a currency whose value is fixed, or “pegged,” to the value of another specified currency, basket of currencies, or commodity like gold.
Pegged Currency Key Points
- Pegged Currency is also known as a fixed exchange rate or pegged exchange rate.
- It refers to a situation where a currency’s value is tied to that of another specified currency, multiple currencies, or a commodity such as gold.
- The objective of pegging is to maintain the stability and predictability of the currency’s value.
- In the context of cryptocurrency, stablecoins are a type of pegged currency.
- A potential downside is that it often necessitates significant reserves to maintain the pegged value.
What is a Pegged Currency?
In economics, a pegged currency is an approach where a country fixes its exchange rate relative to a foreign currency such as the U.S. dollar, Euro, or commodity such as gold. This is done to stabilize its exchange rate, avoid volatility in exchange rates, and maintain predictable exchange rates for trade purposes.
In terms of digital assets such as cryptocurrencies, stablecoins embody the concept of pegged currency. Stablecoins are a form of digital currency that is typically pegged to a reserve of assets. Their stability in price is created and maintained through the pegging mechanism.
Why is Pegging used?
Pegging is used to stabilize a currency by tying its value to that of a more stable and bigger currency or a basket of such currencies. The purpose is to shield the economy from volatility in exchange rates and inflation, and to foster trade and investment by ensuring exchange rate predictability.
Where is a Pegged Currency used?
A pegged currency is predominantly used in countries with less mature economies that suffer from hypersensitivity to economic volatility. Many of these countries routinely peg their currencies to ones like the U.S. dollar or Euro.
In the digital world, pegging is used in creating stablecoins in the blockchain environment. Stablecoins are pegged to a reserve of assets to ensure stable value.
When is a Pegged Currency used?
A pegged currency is utilized when an economy wants to bypass the uncertainties of currency exchange rate fluctuations. This is typically employed in international trade scenarios wherein a stable exchange rate boosts trade and promotes economic growth.
In the blockchain space, a pegged currency, such as a stablecoin, is used when traders want to avoid the drastic swings in cryptocurrency prices and seek a more steady store of value.
How does a Pegged Currency work?
The operation of a pegged currency involves the central bank of a country maintaining a fixed exchange rate to the currency it is pegged to. This is often achieved through massive reserves of foreign currency to enable buying and selling of their own currency to maintain stability.
In the case of a pegged cryptocurrency, a stablecoin is backed by a reserve such as another stable cryptocurrency, fiat currency, or exchange-traded commodities to maintain its price stability. This process is typically governed by smart contracts on the blockchain.
