Important Aspects of Stablecoins: The Difference Between Pegging, Collateralization, and Redeemability

Pegging is commonly associated with the world of foreign exchange, where the currency of one country is fixed or "Pegged" to that of a country with a more stable economy.

With cryptocurrencies today, we see the idea of stablecoins, such as USDVault, TrueUSD, Tether, Circle, Gemini, and Paxos Standard pegging 1:1 to a steady fiat currency like the US Dollar.

Many countries use pegging to fix their currency, most commonly to either the USD or EUR. Very rarely though is it 1:1.

Examples include the Hong Kong Dollar, pegged to the USD at a rate of 7.75 to 7.85, and the Danish Krone pegged to the EUR at 7.46.Different types of pegging.

There are different types of pegging mechanisms and not all pegs are a 100% fixed.

A crawling peg is a fixed exchange rate but one that is allowed to fluctuate between the par value of the pegged currency and a range of predetermined rates.

With a basket peg, a currency will be pegged to more than one currency in a weighted mechanism, comprising currencies of its most important trading partners.

The reason a country might use a basket peg is the same reason an investor would diversify their portfolio; to make the currency even more stable and hedge against the risks a single pegged currency might face when the anchor currency suddenly devalues, such as high inflation.

A currency can also be pegged to a reliable commodity, such as gold.

It's the same principle with gold-backed currencies, where physical gold might be held in reserves to back the currency and to stabilize it, but holders of the currency do not necessarily have a claim on the physical gold, only that they can redeem their currency at a fixed exchange rate against the gold.