Fiat-pegged cryptocurrencies are digital assets that maintain an equal value with a real-world currency. Such digital assets are pegged in a ratio of 1:1 to the fiat currency. This means that every fiat-pegged cryptocurrency carries the same value as the currencies they are pegged to. If a fiat currency is worth $1, then the cryptocurrency pegged to such fiat will be valued at $1.
Fiat-pegged cryptocurrencies, or stablecoins, are typically designed to have a reserve backing them. This reserve helps to prevent the cryptocurrency from de-pegging, that is, from falling below the value of the fiat currency it is pegged to. Stablecoins like USDT, USDC, and BUSD are examples of fiat-pegged cryptocurrencies.
Fiat-pegged cryptocurrencies are not volatile. Cryptocurrencies are known to have high and low swings, but stablecoins were designed to tackle high volatility.
Notably, stablecoins can be pegged to fiat or other commodities such as gold. In the context of this article, the scope is limited to fiat-pegged stablecoins, which are mainly backed by significant fiat currencies such as the dollar, euro, and yen.
Why Use Fiat-Pegged Cryptocurrencies?
Since cryptocurrencies are usually designed to appreciate over time, the usefulness of fiat-pegged cryptocurrencies may be called into question.
Fiat-pegged crypto assets have the edge over regular fiat currencies. They can efficiently be utilized for blockchain activities like trading NFTs and buying in-game collectibles on blockchain gaming platforms.
Stablecoins also have lesser restrictions and a broader reach than regular fiat currencies. Users can send any amount of fiat-pegged cryptocurrencies to another wallet with even lesser fees within seconds.
Stablecoins vary in structure. Some stablecoins can only be issued if the equivalent amount is deposited in fiat.
In contrast, others are known to be algorithmic, meaning they depend on an artificial system that maintains their peg. These types of stablecoins don’t rely on any reserve. They solely rely on algorithms for the maintenance of their peg.
This type of stablecoins has been known to fail as they eventually get de-pegged when a supposed bug compromises the system. A classic example is the Terra UST stablecoin that drastically de-pegged in May 2022. This sent a ripple effect around the cryptocurrency market, which caused a massive downturn. The de-pegging of UST from the one dollar mark increased the fear and uncertainty in traders’ minds at the time. Several traders sold off their assets to prevent further catastrophe.
Tether USDT is an example of a fiat-pegged stablecoin. Although, there have been situations of slight volatility that made it seem like it lost its peg. It is the most used stablecoin based on its popularity.
The biggest holders of fiat-pegged cryptocurrencies are cryptocurrency exchanges.
The stablecoin holdings of an exchange can be an indication of the exchange’s market strength. Exchanges that hold large stablecoin positions are usually protected in the case of unusual volatility since stablecoins could serve as a hedge against volatility.
This way, the cryptocurrency exchange protects investors’ funds. Holding significant stablecoin positions also serves as a source of liquidity for the crypto exchange. Fiat-pegged stablecoins could be a trader’s biggest haven because it is where profits are swapped to and held.