The essence and implementation forms of pegged currencies

Why Pegged Currencies Are Needed

In the cryptocurrency market, many traders and investors want to escape from volatility. To meet this need, the concept of pegged coins has emerged. Pegged coins are assets that adopt a mechanism to minimize price fluctuations by fixing their value to stable assets like the US dollar or gold. This method, which has been utilized in the foreign exchange market for many years, is creating new possibilities through its integration with blockchain technology.

Basic Mechanism of Pegged Currency

For a pegged currency to achieve value stability, continuous management by central banks and financial institutions is essential. For example, if a currency is pegged to the US dollar, when its price deviates significantly from the benchmark, the authorities will implement market interventions. Specifically, adjustments are made by buying and selling the currency in exchange for US dollars to bring the price back to its original level. This safety net function ensures that the value of the currency remains within a predictable range.

Major Forms of Pegged Currencies

fixed exchange rate system

This is the simplest method. The price of pegged currency is completely fixed to a single foreign currency such as the US dollar or Euro. It is an approach often adopted by countries with frequent foreign trade.

Crawling Peg System

It is a more flexible system. The price of pegged currencies is adjusted in small increments over a long period based on market conditions and the prices of the currencies they are linked to. It has the characteristic of gradually responding to market changes while avoiding sudden fluctuations.

coin basket system

This is a method of pegging a currency to a basket that combines multiple foreign coins. It can avoid excessive reliance on a single coin and is expected to provide risk diversification effects.

Pegged Currency in the Blockchain Era: Stablecoin

The concept of pegged currency has been embodied as stablecoins in the blockchain market. Stablecoins are crypto assets designed to minimize volatility by pegging to stable assets such as fiat currencies or gold. They serve as a practical solution for investors and traders who want to be protected from price fluctuations while avoiding traditional fiat currency exchanges.

Well-designed stablecoins function as a means to achieve regular returns on a blockchain network, avoid volatility, and enable reliable value transfer.

Algorithmic Stablecoins: Innovation and Challenges

In contrast to traditional reserve-backed stablecoins, algorithmic stablecoins represent a more experimental approach. By utilizing smart contracts and algorithms, they attempt to maintain their value at an appropriate level without physical reserves. While it is an excellent concept in theory, in practice, it becomes more difficult to predict prices compared to reserve-based forms. In fact, there are numerous instances of significant losses caused by algorithmic stablecoins losing their peg, highlighting the risk factors associated with this mechanism.