Peg

November 21, 2023 - Around 2 mins mins to read

Understanding the Concept of a Peg

A “peg” is a term used to describe a predetermined price for the exchange rate between two assets. Unlike “floating” currencies, which have flexible price targets and follow more relaxed monetary policies, a pegged currency maintains a fixed exchange rate.

In the global currency market, a peg allows foreign currencies to be traded for a specific base currency at a predetermined exchange rate. Establishing a peg offers several advantages, including facilitating international trade, minimizing risks associated with entering new markets, and promoting stability in macroeconomic activities.

In the realm of cryptocurrency, a peg refers to the specific price that a token aims to maintain. This concept is primarily observed in stablecoins, which are digital assets designed to retain their value over an extended period. Notable examples of stablecoins include USDT, DAI, and FRAX, all of which are pegged to the value of $1. The US dollar itself is considered “soft-pegged” to the consumer price index (CPI), which tracks a basket of goods.

Stablecoins ensure their peg by adjusting the total supply through contraction or dilution. Changes in the token supply impact the relative price of each token until it aligns with the desired peg. Collateralized stablecoins like USDT and DAI are created or destroyed as needed, with newly minted tokens receiving collateral backing in the form of other digital assets.

Algorithmic stablecoins, on the other hand, maintain their peg through a combination of collateralization and the utilization of complex smart contract algorithms. These algorithms contract or expand the supply based on various market factors.

Sam Kazemian, the CEO of Frax, provides insights into the concept of pegs in his article. Frax is a fractional algorithmic stablecoin that is partially backed by collateral and stabilized algorithmically. It is the only fractional stablecoin that has successfully maintained its peg since its inception. Frax is an open-source and permissionless project that aims to bring a truly trustless, scalable, and stable asset to the future of decentralized finance.

Kazemian has extensive experience as a prominent blockchain entrepreneur and cryptocurrency enthusiast. He is also the co-founder of Everipedia, a blockchain-based knowledge base. Kazemian’s journey in the crypto space began in 2013 at UCLA, where he started mining cryptocurrency in his college dorm room. Today, he frequently lectures at UCLA on topics such as cryptocurrency, computer science, and entrepreneurship.