In finance, the term “pegging” means adopting a fixed exchange rate between certain currencies to keep them stable. This idea has been implemented in the crypto market, where a stablecoin is pegged to real-world assets to ensure its value does not fluctuate. The process is referred to as hard pegging.
This article discusses everything about hard pegging and explores some of the most used stablecoins.
What’s Hard Pegging in Crypto?
Before explaining hard pegging in detail, it is important you first understand the idea behind pegging. In the crypto world, wild price volatility has made it tough for investors and businesses to rely on cryptocurrencies to conduct various transactions. So some companies, like Tether and Circle, have created stablecoins to shield crypto users from high market volatility.
As mentioned earlier, stablecoins maintain their value by being attached to stable assets like commodities and fiat currencies.
Such assets serve as reserves, giving a 1:1 ratio. That means if a stablecoin is pegged, let’s say to USD, then one token can be cashed out for $1. Since the coin’s value does not fluctuate, we can consider this to be hard pegging.
Hard Peg vs. Soft Peg
While a hard peg ensures a stablecoin’s value is not subject to fluctuations, a soft peg, on the other hand, allows for predefined flexibility between the stablecoin and its backing asset. A good example of a stablecoin with a soft peg is USDT. Even though its expected price is $1, It’s allowed to increase or decrease by 2%.
What’s Depegging in Crypto?
If a stablecoin has 1,000,000 tokens in circulation, the issuer is supposed to hold enough reserves to back each circulating token to allow easy crypto-to-fiat conversion. Furthermore, there is a “depegging” risk in case the backing assets are insufficient. But what’s depegging? It is a scenario where a stablecoin is unable to maintain its intended price due to inadequate reserves. Such an event can cause investors to lose their funds.
The most popular depegging incident occurred last year when UST plummeted massively after losing its peg. It is reported that investors collectively lost more than $35 billion to this unfortunate event.
Types of Stablecoins
While most stablecoins are backed by real-world assets, there are some backed by cryptocurrencies, and others use computer algorithms.
Fiat-Backed Stablecoins
These stablecoins use fiat currencies as reserves. The most used currency is the United States dollar. Fiat-backed stablecoins are considered centralized since they are issued and managed by private entities. The three well-known stablecoins under this category are BUSD, USDT, and USDC.
Crypto-Backed Stablecoins
As the name suggests, crypto-backed stablecoins are collateralized by other crypto assets. It s important to highlight that such stablecoins are usually over-collateralized, meaning the reserves held outnumber the circulating tokens significantly. An excellent example is MakerDAO’s stablecoin DAI. It is backed by huge amounts of Ether and other crypto assets.
Commodity-Backed Stablecoins
Commodity-backed stablecoins use tangible assets like gold or crude oil to maintain their value. Paxos Gold is an example of such stablecoins.
Algorithmic Stablecoins
These stablecoins are not backed by any assets. Instead, they retain their value using a computer algorithm that controls their demand and supply. For example, when an algorithmic stablecoin trades above the expected price, a special code in the smart contract will automatically add more tokens to the circulating supply to lower the price. And the vice-versa is true.
The Future of Stablecoins
Since UST’s depegging incident last May, the United States authorities have looked to impose stricter regulations on stablecoins. This year alone, four bills related to this crypto asset class have already been tabled in the US House of Representatives and the Senate.
Meanwhile, some stablecoin issuers like Paxos and Circle have ongoing legal battles. This raises concerns over the stability of the stablecoins market.
Nonetheless, Tether CTO Paolo Ardoino believes stablecoins could be here for a long time if the regulators provide clear guidance on how companies should operate these crypto assets. He says the rules are unclear at the moment.
SureTradeGroup.com is not responsible for the content, accuracy, quality, advertising, products or any other content posted on the site. Some of the content on this site is paid content that is not written or posted by our writers or editors and the opinions expressed do not reflect the opinions of this website. Any disagreement you may have with brands or companies mentioned in articles will need to be taken care of directly with those specific brands and companies. The responsibility of anyone who may click links in our articles and ultimately sign up for that product or service is their own. Forex, Stocks, Cryptocurrencies, NFTs and Dogital Tokens are all a high-risk asset, investing in them can lead to losses. Readers should do their own research before taking any action.