Understanding Fiat-Pegged Cryptocurrency
A Fiat-Pegged Cryptocurrency, also referred to as a “pegged cryptocurrency,” is a type of digital coin, token, or asset that is issued on a blockchain and is tied to a government or bank-issued currency. The key characteristic of these cryptocurrencies is that they always maintain a specific cash value in reserves.
Fiat-pegged cryptocurrencies fall under the category of stablecoins, which were created to address the problem of extreme volatility in the cryptocurrency market. Unlike traditional cryptocurrencies, stablecoins are designed to have a stable value by being pegged to major currencies such as the euro, the British pound, or the U.S. dollar.
The reason for pegging stablecoins to fiat currencies is that while fiat currencies can experience depreciation against other currencies, they are less likely to undergo significant fluctuations in value. By linking stablecoins to fiat currencies, their value remains relatively stable, making them more suitable for everyday transactions.
There are various structures for fiat-pegged cryptocurrencies. Some have a strict structure, meaning they can only be issued if a unit of fiat money is deposited. One well-known example of a fiat-backed cryptocurrency is Tether, which has faced controversy due to its claims of being backed by the U.S. dollar. However, it expanded its backing to include loans to affiliate companies, which are considered less stable than fiat-backed currencies.
Cryptocurrency exchanges are the primary holders of fiat-backed cryptocurrencies. This is because exchanges need to safeguard their positions from price volatility by holding reserves in the form of fiat-backed assets. Additionally, holding fiat-pegged cryptocurrencies helps enhance the liquidity base of exchanges. Some exchanges may not have access to banking services, so holding these cryptocurrencies acts as a hedge against such limitations.