Pegged and Depegged Cryptocurrencies Explanation

Many often wonder, "what does pegging mean in crypto?". Pegging in cryptocurrency refers to linking a cryptocurrency's market value to an external reference. The external reference can either be a commodity or a fiat currency. A cryptocurrency's pegged price is the price the cryptocurrency tries to attain to minimise volatility.

Depegging in cryptocurrency is when a stablecoin digresses from the initially intended peg. Events that lead to depegging are every day in the crypto and fiat space. Cryptocurrency pegging helps protect a coin's value against severe price fluctuations. It helps to stabilise the value of a cryptocurrency.

What Is Pegging in Cryptocurrency?

Pegged cryptocurrency is fixing or tying a cryptocurrency's value to another external asset. It is often done in various ways; however, the most common way is by linking the value of two currencies together in a 1:1 ratio. For example, the USDT and USDC are pegged to the US dollar and are used in the best paid online casino.

A currency peg is often done to stabilise or protect the prices of these assets against volatility. It is often used for stablecoins in the cryptocurrency world. Stablecoin is a type of cryptocurrency that maintains a stable value. One of the many ways to peg a stablecoin is by using a collateralised debt obligation.

A collateralised debt obligation is where a pool of assets backs the value of a coin. The assets in the pool help to collateralise the value of a coin while also protecting it from volatility. Another way of pegging a coin is by using a smart contract. A smart contract is a type of contract written on a blockchain.

One of the main benefits of pegging a fiat currency and a cryptocurrency together is that it gives the pegged cryptocurrency token or coin stability in a volatile crypto space. It also helps to create a store of value of the currency, which is beneficial to investors holding their coins for a long time.

Another benefit of pegged cryptocurrency is that it is another way to shield against inflation. Understanding what pegging means in crypto and how to use it before investing in cryptocurrencies is advisable.

How to Implement Currency Pegs

A digital currency can be pegged in various ways depending on the type of stablecoin. Some of the ways a digital currency can be pegged are:

• Algorithms: The stablecoins that involve algorithms are primarily not backed by an asset. These coins are often controlled by using a blockchain smart contracts code and are less centralised and unregulated. It also involves the algorithmic management of supply and demand to maintain a peg. One of the famous algorithmic stablecoins that collapsed is Terra's UST.

• Reserve Maintenance: Only centralised stablecoins use this traditional pegging method because their values are secured in a centrally managed vault. An asset or a currency backs a fiat-backed stablecoin.

Volatility in Pegged Cryptocurrencies

Pegging can help to stabilise the crypto market. There is a lot of price volatility in cryptocurrency because crypto prices often swing in both directions. The price swing makes it tough to manage and predict; however, pegging is a tool that helps stabilise the volatile crypto markets. It also helps to gain the trust of the crypto community and the global financial sector.

One common way to set a cryptocurrency's price to a stable value is by the US dollar-cost averaging process. With this process, an individual can set a fixed amount of fiat currencies they can spend on a specific cryptocurrency and purchase it at regular intervals. Over time, this helps to smooth the swing in price and give a more stable price and help with pegged asset mimics.

The following are some of the reasons for pegging the price of crypto:

• It helps to manage risk by allowing you to avoid losses by making better investment decisions.

• Pegging helps an individual to take advantage of price fluctuations.

• It also makes it easier for an individual to use cryptocurrency in their everyday life.

Reserve Fiat Currency and Pegged Cryptocurrencies

The owners of cryptocurrency must hold the value in a pegged asset to them, which is sufficient to provide a guarantee. It is vital before these owners can be pegged to a particular type of asset. This pegging enables them to convert the pegged currency or bank-issued currency in their possession to another type of asset at will.

Crypto developers who intend to peg their cryptocurrency to a fiat currency must ensure to hold the currency in reserve. Keeping the currency in reserve always helps to back up their claim for stability. It ensures that the owners can exchange their crypto tokens at a good currency’s exchange rate for their share of the fiat currencies if the value of the pegged cryptocurrency falls.

The developers also need help to back their pegged crypto tokens by holding onto a large amount of fiat currency. It is one of the reasons they turn to fundraise and crypto investors when building their reserve for fiat. If you want to relax after reading about cryptocurrency prospects, you can read some information about gambling luck astrology.

Examples of Pegged Cryptocurrencies

Several stablecoins are pegged to major currencies, some of which are USD, EUR, and GBP. A popular cryptocurrency pegged to the USD is Tether. The US dollar tether, often known as USDT maintains the same pegged value of $1. This value indicates a 1:1 pegging; hence the one USDT digital currencies token always has a value of $1 at the exchange rate.

However, in 2020, Tether announced that one of its issuers would be the Solana blockchain. USDT is one of the world's most popularly pegged crypto tokens since it can be exchanged for thousands of cryptocurrencies on various centralised currency exchange rate channels. Examples of some of the stablecoins also pegged to the USD are Pax Dollar, TrueUSD, and Binance USD.

The following are a list of pegged cryptocurrency and their national currency or nature:

• UST: Pegged to $1, and it is decentralised

• USDT: Pegged to $1, and it is centralised

• PAXG: Pegged to Gold, and it is centralised

• USDC: Pegged to $1, and it is centralised

What Is Depegging in Cryptocurrency?

Depegging is when a stablecoin diverts from its intended peg. When depegging happens, it questions the effectiveness of the affected currency and its ability to stick to the intended peg. For example, when there is a drop in the value of a US dollar-pegged stablecoin which makes its value under $1, the coin is depegged.

There are common depegging events in crypto and fiat spaces, such as the loss of the Thai Baht's US dollar peg in 1997. In the case of algorithmic stablecoins, depegging signals catastrophe where the computer code manages the supply and exchange rate of the token. When the market crashes fast and outperforms the algorithm, the currency loses its peg.

In mid-May 2022, the news of USDT depegging hit the crypto world. This event caused a market crash, making the community question the stability of other coins in the market. Several individuals were surprised about the stablecoin peg break that was ensured. The Terra stablecoin USDT lost its peg in the middle of May 2022.

Depegging events are often experienced by crypto and fiat, and the loss of the Thai Baht's USD peg in 1997 is an example of how it can occur. The average ratio of LFG (Luna Foundation Guard) reserves to the TVL is estimated to be 0.12 leading to the depegging of the USDT. During the turmoil of 2018, Tether rose to $1.32 in July; however, it dipped to $0.51 in October.

Investors are to ensure to know about the risks involved in the stablecoins. As an investor, it is advisable not to assume that all stablecoins carry an equal level of risk.

Sudden Causes of Depegging

The following are some of the causes of a sudden depegging:

• Business Model Factor: One of the reasons for the depegging of a stablecoin is the lack of a workable business model. For example, the USDT is an example of an algorithmic stablecoin with a system that does not work efficiently.

• Mismatched Reserves: A stablecoin backed by underlying assets will not experience a currency peg when there is a failure in the 1:1 backing of the tokens with the underlying asset. For this to occur, the markets must be aware of the possible mismatch in digital currencies. Generally, some stablecoins like Tether do not provide this information to the public. They do not transparently reveal this information because it affects their interests.

• Unfavourable Regulation: In a situation where the government issues a regulation that is not favourable, the confidence of the investors in the stablecoin will reduce.

• Markets Outperform the Algorithm: By using demand and supply, smart contracts can secure the currency peg of an underlying asset to an extent. However, when the market crashes too fast or outperforms the algorithm, the currency will lose its peg.

How to Prevent Depegging Events?

The following are the two common ways of preventing depegging events:

• Arbitrage: A strong arbitrage mechanism will help the algorithmic stablecoins to protect smart contract management. When a stablecoin trades below 1 dollar, arbitrageurs can make cheap purchases and exchange it later for $1. This helps to restore the peg while earning a profit.

• Regulation: Although cryptocurrencies are seen as anti-government, sound compliance measures and regulations are in place. These regulations help to ensure that the pegged asset is backed up by an adequate reserve.

Conclusion

Pegging in cryptocurrency refers to linking a cryptocurrency's market value to a commodity, fiat currency or another external reference. It helps to ensure the close alignment of the market and pegged price. The USD is a dominant currency; hence several cryptocurrencies are pegged to it. It is advisable to know what pegging means in crypto before investing.

However, depegging is where a stablecoin deviates from its intended peg. There are depegging events that can occur to both the fiat and crypto. When a stablecoin is pegged to a dollar, and it loses its peg, i.e. it has fallen under a dollar, the investors' confidence in the coin reduces.