What Is a Convertible Currency?
A currency that can be readily bought or sold without government restrictions, in order to purchase another currency. A convertible currency is a liquid instrument when compared to currencies tightly controlled by a central bank or other regulating authority.
A convertible currency is often referred to a hard currency.
How a Convertible Currency Works
Developing countries or those with more authoritative governments are more likely to place restrictions on the exchange of currencies. Currencies from these countries are typically less stable, and may come from economies with high inflation rates, and are more illiquid, which does not fit the definition of a convertible currency.
Convertibility is important in international trade, it allows companies to do business across borders with confidence and transparent pricing. Also, a convertible currency is more liquid, which reduces volatility.
The most convertible currency is the U.S. dollar. It is the most traded currency in the world. Central banks hold the U.S. dollar as their main reserve and a number of asset classes are denominated in U.S. dollars, meaning payment and settlements are made in U.S. dollars. Currencies such as the South Korean won, and Chinese Yuan are deemed convertible, but on the lesser side, as the government places capital controls that limits the amount that can exit or enter the country.
Some socialist countries such as Cuba and North Korea even issue nonconvertible currency.