What Does Pegging Mean in Crypto?
In the traditional sense, most countries link the exchange rate of their government or bank-issued currencies to the value of other currencies. This is known as currency pegging or pegged currency.
In the cryptocurrency context, pegging is the process of attaching one coin’s market value to the value of another coin or real-world asset, such as gold or fiat currency. The goal of pegging is to stabilize a cryptocurrency asset by tying its value to a cryptocurrency or asset that maintains a consistent value. It is often linked to the designated asset or crypto at a predefined ratio. Once the ratio is established, the value of the cryptocurrency moves in the same direction as the value of the asset it is ‘pegged’ to.
To peg a cryptocurrency to another asset, the project behind the crypto must hold a sufficient amount of the designated asset. In addition, they must maintain this reserve at all times to back their stability claim. This ensures that they can compensate users when they claim back their share of the designated asset anytime.
The most common use case of pegging in the crypto space is stablecoins, a type of cryptocurrency asset that is attached to a less volatile asset. These cryptocurrencies are designed to offer price stability regardless of market direction. For instance, crypto projects may link their cryptocurrency value to fiat money in a 1:1 ratio. This enables users to securely store a steady, less volatile value during market fluctuations.
However, pegged cryptocurrencies do not always maintain the predetermined ratio. When they increase or decrease in value relative to the asset they are pegged to, they are said to have depegged.
Examples of Pegged Cryptocurrencies
Pegged cryptocurrencies type are fiat, crypto, algorithmic, or commodity.
Fiat-pegged cryptocurrencies are attached to fiat money in a 1:1 ratio, such as the US Dollar, Sterling Pound, or Euro. Basically, the value they hold is relative to the value of the underlying conventional money. This makes them easily convertible to fiat currencies.
On the other hand, cryptocurrency-pegged digital assets are collateralized by other less volatile crypto assets while commodity-pegged cryptocurrencies are attached to the prices of tangible assets, such as gold and silver at a specific ratio. Finally, algorithmic stablecoins are cryptocurrencies that, instead of pegging to other assets, use an algorithm to maintain price stability by controlling the coin’s supply.