In the ever-changing digital currency world, it's hard to predict which tokens or coins will be the hottest months, weeks, or even days into the future. Indeed, it can be difficult to predict which cryptocurrencies will even exist looking forward, as new coins are launched all the time. Along with this general unpredictability, investors in the cryptocurrency space have been plagued by massive volatility. A glimpse at the price history of bitcoin over the past year will confirm this.
At its peak, in late 2020, bitcoin reached just over $40,000 per coin, exceeding parity with gold. At this time, investors who had been previously resistant to the new industry began to take notice. While the price of bitcoin has remained volatile, there nonetheless remains keen interest in digital currencies that could hold a more stable value by being linked to some other asset of value like gold in some way.
As a result, and perhaps also fueling this interest, more and more developers have launched or planned for cryptocurrencies that are pegged to the precious metal, to the dollar, or to other fiat currencies, which might provide more stability than other digital currencies normally see. Below, we'll explore pegged digital currencies and compare gold- and USD-pegged options.
- As the cryptocurrency market has grown, developers have created digital tokens whose values are pegged to certain assets such as gold or dollars.
- Known as stablecoins, these tokens may be pegged to a national currency like the U.S. dollar or to a commodity's price such as gold.
- Stablecoins achieve their price stability via collateralization (backing) or through algorithmic mechanisms of buying and selling the reference asset or its derivatives.
Pegged Cryptocurrency Overview
A so-called stablecoin is a new class of digital token that attempts to provide price stability through being backed by a reserve asset. Stablecoins have gained traction as they attempt to offer the best of both worlds—the instant processing and security or privacy of payments of cryptocurrencies, and the volatility-free stable valuations of fiat currencies.
Pegged digital currencies are those that are linked to the specific value of a bank-issued currency or other commodity. Tether is a popular example of a digital currency that is pegged to the U.S. dollar; one USDT token is always valued at $1. Before an investor begins to exchange his dollars for cryptocurrency tokens, though, it's important to keep in mind how this pegging works.
Cryptocurrency developers wishing to peg their tokens to a fiat currency must be able to back up their claim, typically by holding that currency in reserve at all times. The thinking is that if the cryptocurrency fails for some reason (say, due to a blockchain error, fraud, or some other issue), the cryptocurrency tokens that investors hold are really only worth $1 each if investors can then go to the developers to claim their share of fiat currency in exchange for the tokens they held.
Holding large amounts of fiat currency in reserve is often a difficult challenge for pegged digital currencies. Developers must rely on investors, fundraising efforts, and other means of building up a reserve of currency to back their digital tokens. Another issue is that there is no chance of profit to be gained from either buying or selling the digital tokens, as they will always maintain the same fiat currency value.
Developers have had an interest in creating a gold-backed digital currency since the earliest days of the industry. Gold-backed digital currencies link one token or coin to a specific quantity of gold (for instance, 1 token equals 1 gram of gold). The gold, like dollars or other fiat currency, must be held in reserve, typically by a third party.
One advantage to gold-pegged digital currencies is that the baseline or minimum value of the token will always be equal to the fixed amount of gold. If the digital currency becomes popular, the price of the coin can actually exceed that value. In this way, gold-pegged digital currencies offer protection against the bottom dropping out of a digital currency's value.
On the other hand, there are also risks with gold-pegged digital currencies. Blockchain is a highly secure means of tracking transactions in digital currencies; however, these tokens introduce the concern of storing a large supply of physical gold. Thus, investors should be careful to examine who stores the gold for a particular cryptocurrency and where it is housed before investing. If the gold disappears for any reason, the value of the token does too. Transparency between cryptocurrency developers, third-party holders of gold, and investors is crucial to building investor trust and, in turn, value in the digital tokens themselves.
Like gold-backed digital currencies, USD-pegged cryptocurrencies also face the added risk of requiring the storage of large amounts of fiat currency. Besides this, government regulators do not look kindly on companies attempting to create a new product that is linked to the value of a central bank currency. Successful USD-pegged digital currencies typically have licenses in order to provide this service, and the companies themselves must maintain public records of their holdings.
The most important thing for a USD-backed digital currency, though, is investor demand. Developers must be able to offer investors a good reason to store their assets in digital tokens rather than fiat currency, and the fact that the two are always valued the same can make that difficult. Even some of the most successful USD-pegged digital currencies have run into issues in this regard, with supply exceeding demand and digital tokens eventually collapsing. Nonetheless, this remains an area of interest for many cryptocurrency enthusiasts, and it is one to watch for developments as the industry continues to grow.
Investing in cryptocurrencies and Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns bitcoin and ripple.