The world of cryptocurrency can seem weird and wonderful at the same time. There are so many different digital tokens out there, each with its own purpose and risk profile. One unusual type of cryptocurrency is pegged tokens so called because their value is directly linked to that of another asset, such as gold or a fiat currency like the US dollar. In this article, we’ll explain what pegging means in crypto and how it works. Read on to find out more.
What Does “Pegging” Mean in Crypto?
In cryptocurrencies as in most other types of investment, a “peg” is a rate at which one asset is exchanged for another, typically via a trading platform such as BitAlpha AI. The word is used particularly when talking about fiat currencies, such as the US dollar, being pegged to gold or another commodity. The term comes from the idea that a ship’s anchor is “grounded” in the seabed, allowing it to stay in one place. In the same way, pegging currencies allows them to remain stable, rather than being subject to the whims of traders. In cryptocurrency, “pegging” means creating a token whose value is derived from that of another asset, such as another cryptocurrency, fiat currency or even a commodity like gold. This is part of the broader concept of creating “stablecoins”—cryptocurrencies that have low volatility and can be used as a store of value.
How Do Pegged Cryptocurrencies Work?
When discussing pegging in crypto, we’re referring to “asset-backed” or “collateralized” tokens. These work in a similar way to securing a loan with a mortgage on a house. The “token” is the digital asset that is issued, like a loan of money. The underlying asset is whatever the token is pegged to, such as gold or the US dollar. There are a few different ways to create an asset-backed cryptocurrency. One way is to create a “smart contract” that directly links the token’s value to that of the underlying asset. Another option is to “anchor” the token to another token that is already pegged to an asset. Yet another way is to create a token that is backed by a fiat currency or another asset.
Pros of Pegging in Cryptocurrency
There are plenty of good reasons why cryptocurrencies might be pegged to other assets. The most obvious reason is to create a safe store of value. A stablecoin that is pegged to the US dollar, for example, will hold its value in line with the USD. This means that it can be used as a reliable medium of exchange. If a cryptocurrency’s price falls, it becomes less useful as a means of payment. If it rises, it loses its appeal as a store of value. Asset-backed cryptocurrencies will hold their value much more consistently. You can easily monitor the value of a coin through a trading platform such as BitAlpha AI. Another reason to peg a cryptocurrency to another asset is to make it more “legitimate”. A digital token that is pegged to a widely accepted fiat currency or commodity like gold will be taken more seriously by investors. It will also be easier for new users to understand what the token does.
Cons of Pegging in Cryptocurrency
One of the major risks of pegging a cryptocurrency to another asset is that that asset might not remain stable. If the value of the asset the cryptocurrency is pegged to falls, the digital token will also look less appealing. Similarly, if the value of the asset rises, the cryptocurrency will lose its appeal. A cryptocurrency that is pegged to another asset also faces the risk of being outlawed. If the asset being used as the peg is outlawed, the cryptocurrency that is pegged to it will also be affected.
Key takeaway
Pegging a cryptocurrency to another asset can provide stability and also legitimize an otherwise obscure token. However, if that asset loses value, so will the pegged cryptocurrency. As well as being pegged to other assets, some cryptocurrencies are designed to be pegged to each other. This allows users to trade tokens directly with each other without the need for a middleman, such as a cryptocurrency exchange. The advantages of using these so-called “decentralized exchanges” are discussed in a separate article.
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