Today, most people are familiar with cryptocurrencies. Crypto has become incredibly popular and more individuals are starting to invest in digital currencies every day. One of the most famous cryptocurrencies is Bitcoin. As more people become intrigued with crypto, the first thing they learn is how volatile it can be.
For example, on one day Bitcoin could be standing at an all-time high and the next day its value could have dropped by more than 10%. This is where pegged cryptocurrency makes an introduction.
These are cryptocurrencies that are tied to commodities or other currencies such as the U.S. dollar. They are more stable than regular cryptocurrencies and their less volatile nature makes them better suited for the medium of exchange.
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SubscribeA Deep Dive Into Pegged Cryptocurrencies
Pegged cryptocurrencies — commonly referred to as stablecoins — are tied or linked to another asset. Many of them are linked to fiat currencies such as the USD, GBP, or EUR with a 1:1 ratio. In other words, if the pegged currency is linked to the GBP, one stablecoin would equal one British pound sterling.
This provides the cryptocurrency with more stability, making it less volatile. Stablecoins can also be tied to commodities such as silver or gold. Most people, when they hear cryptocurrency, think of trading and investing. However, individuals holding these digital currencies can use them for much more.
People can utilize them for different purposes such as online shopping, booking traveling trips, purchasing real estate, and much more. Another common use case is crypto casinos. For example, people can deposit with USDT and use Tether to place their bets.
In fact, the popularity of online casinos that trade with crypto has become tremendously popular. That said, due to cryptocurrency’s volatile nature, people tend to use them less as a medium of exchange. The reason for this is that a seller does not want to part with the object they are selling, just for the currency to decrease in value the next day.
Or in the case of the buyer, where the cryptocurrency ascends in value, resulting in them overpaying for the item they bought the previous day. Both parties need some form of assurance that the currency used in the exchange will stay stable and not result in them suffering losses.
This is where pegged cryptocurrency comes in. As previously mentioned, due to them being tied to another asset that offers more stability, they are more suited as a way of exchange. This makes stablecoins more practical for purchasing things than regular crypto.
How Does Pegged Cryptocurrency Work?
The way that stablecoins work is that they are pegged to another currency or commodity, thus helping to maintain stability. In most cases, they are usually tied to fiat currencies. In addition, to help maintain the stablecoin value, reserves are kept as a form of collateral — usually the asset it is linked to.
If the pegged currency is linked to the U.S. dollar, then reserves of the USD will be kept. However, not all stablecoins operate this way. To better comprehend how stablecoins work and maintain their value, it is essential to understand the three types of pegged cryptocurrencies.
Fiat-Collateralized Stablecoins
These are the stablecoins mentioned above. They are linked to a fiat currency such as the USD or EUR. To help ensure the pegged cryptocurrency’s value, reserves of cash are kept, usually the U.S. dollar.
However, other forms of collateral can also be used such as commodities like gold, silver, other currencies, or even crude oil. A well-known stablecoin that is linked to the U.S. dollar is Tether. As of writing, the current USDT market cap is $112,43 billion.
Algorithmic Stablecoins
Algorithmic stablecoins are different from fiat-collateralized stablecoins. While the pegged cryptocurrency could still keep reserves, this is not the primary way that the stablecoin maintains its value.
Instead, an algorithm is used to help control the supply of the stablecoin. In other words, to sustain stability, a computer program automatically increases and decreases the supply of the cryptocurrency.
For example, if the coin starts trading under the value it’s linked to, the algorithm can destroy existing coins helping it to align with the pegged value. The same applies when the coin is trading above the pegged value. In this case, the program will create more coins instead of destroying them.
Crypto-Collateralized Stablecoins
These coins are similar to fiat-collateralized stablecoins with the exception of them being tied to other crypto instead of fiat currencies or commodities. To circumvent crypto’s volatile nature, the kept value is over-collateralized. Meaning, that more of the cryptocurrency is kept than the value the stablecoin is pegged to.
Conclusion
Stablecoins help to decrease the volatility that regular crypto faces. To achieve this, the cryptocurrency is linked to another external asset. Thus making pegged crypto more stable and more suited for the medium of exchange.
The type of stablecoin depends on whether it is linked to a fiat currency, another crypto, or if it utilizes algorithms to control the supply. Considering that regular crypto’s value can change at any moment, stablecoins serve as a way to balance the scales and keep that volatility in check.
