“Peg” or price stability is one of the most important concepts in the world of stablecoins or digital stable currencies. Maintaining a peg to the dollar for these types of currencies and minimizing price fluctuations within this price range provides arbitrage opportunities and profits for large traders and helps maintain the security and scalability of coins. Various types of these coins have been proposed to date, and in this article, we intend to examine the general question of what PEG is and its applications.
What is Price Pegging, and What is Its Impact on DeFi?
The controversy surrounding the death of the stablecoin UST continues in the crypto space. At the very least, one can look at the date in a way that such an event led to fewer people flocking to new stablecoins and more regulations being implemented by governments, especially the United States, regarding stablecoins. From this event, numerous articles and podcasts have been published about the fall of UST stablecoin and its impact on the future of DeFi. The consequences and lessons of this event reflect only one concept: the need to avoid pegs or uncontrollable dependencies for stablecoins.
Stablecoin designers initially tried to ensure the price stability theory of a digital asset. It didn’t take long for them to realize that traders were looking for a stablecoin that could always trade at its declared value, not a tool they wanted to trade at a fixed level.
In fact, this is a lesson we can learn from traditional financial matters, which have a long history of managing pegs. When price dependence is maintained for a stablecoin, we see that the flow of investment becomes more difficult, but during this process, only a slight price deviation is needed to erode investor confidence.
DeFi platform stablecoins have various approaches to managing price dependence. In response to the question of what PEG is, we will look into the strategies of well-known stablecoins. Although the Curve platform has made the scalability of new stablecoins possible, it may not be the ultimate solution for managing pegs.
Key Points from Traditional Finance in Peg Management
Just like many concepts in the field of cryptocurrencies, the concept of peg is not a new concept in financial affairs, but it has a rich history.
Soros Led to the Collapse of the Bank of England
In 1990, the UK joined the European Exchange Rate Mechanism (ERM) group, which was supposed to allow the continuation of the monetary process in Europe before the introduction of the euro. The ERM mechanism allowed the exchange of major European currencies with the Deutsche Mark (the common currency in Germany) at a fixed price range. This law was enforced by the central bank of each country at that time.
Until 1992, the British pound (GBP) was trading at the lower end of this price range. At that time, the UK economy was very weak, and inflation was rampant in the country. This was while the fixed rate approach of ERM came to the aid of Britain and prevented market adjustment. This process continued until George Soros and other currency speculators entered the foreign exchange market and forced the Bank of England (BoE) to defend the pound price by applying short and heavy contracts on the pound.
The Value of the Thai Baht During the 1997 Asian Financial Crisis
The Thai Baht, the currency of Thailand, was heavily tied to the US Dollar in the 1950s, which caused the country to face multiple financial crises. Ultimately, due to a decrease in exports, an increase in the US Federal Reserve’s interest rates, and a central bank crisis resulting from foreign exchange reserves, the Thai central bank gradually allowed the Baht to freely exit the country without any legal restrictions. When the financial crisis hit Thailand, the value of the US Dollar gradually increased, and in the midst of this, foreign investors made every effort to withdraw their capital from Thailand to preserve it.
In 2008, several short-term loans faced difficulties, and the net asset value of the primary reserve fund remained below $1 per share. While this might be seen as a minor deviation in price, it’s interesting to note that this seemingly minor event caused the fund to lose over $40 billion of its capital. This event not only affected the primary reserve fund but also made other funds apprehensive. As a result, the US Treasury was forced to repurchase the sold-off dollars to return prices to the dollar.
Inflation in Germany
The British Pound Sterling was pegged at a fixed and uniform rate in 1990, and simultaneously, the UK joined the Exchange Rate Mechanism (ERM) as part of the European currencies. In the case of the Pound Sterling, this happened under a legal framework enforced by the member countries of this group. It was in 1992 when the Pound Sterling experienced an unfortunate event, reaching its lowest level. This event had consequences, one of which was the creation of very high inflation in the UK. However, the fixed-rate mechanism saved the UK from inflation at the time and brought the country’s situation under control.
The unfortunate event was not supposed to end here as currency speculators like George Soros entered the scene and made contracts that would profit from the sale of the Pound Sterling. This event prompted the Bank of England to prepare for its defense, and the Black Wednesday happened. At that time, after speculators got involved, the Bank of England had no choice but to buy back over £2 billion in just 24 hours, dealing a major blow to the country’s economy. Let’s also talk about the profits George Soros made during this time. George Soros made $1.5 billion in profits from this event, and it can be said that the result of this event was only beneficial for him and speculators.
Overview of Peg-Based Digital Currencies
Before we introduce various types of cryptocurrencies that have price pegs, it’s important to note that long-term monetary policies cautiously have no influence on foundational digital currencies, and central banks do not support these digital currencies. The only advantage of stablecoins in the digital currency market is their inherent stability. Below, we introduce cryptocurrencies based on price pegs:
USDC and BUSD
You can purchase USDC and BUSD using the common currency of the United States, the dollar. To do this, simply visit a reputable exchange like Binance to buy the required amount of these cryptocurrencies with just a few simple clicks. If the price of USDC and BUSD exceeds one dollar, this is good news for market participants because instead of keeping their money in banks, they invest it in USDC and BUSD. This increases the amount of investment in these two digital currencies, and as a result, the number of transactions made in them also increases.
USDT or Tether
Tether is not backed by dollars held in a bank but is supported by off-chain assets. In fact, Tether can be seen as a fund where the investment location is not known to traders. The peg of Tether to major exchanges active in the digital currency market depends on these exchanges. In fact, small investors in digital currencies who are not among the major investors do not have the ability to convert their Tether to dollars, but major investors do. This is why even if the price of Tether falls below one dollar, large investors in the market come to the rescue and stabilize its price by buying Tether.
So far, the price of Tether has never exceeded one dollar, meaning that pricing policies in this digital currency have been effective, and market participants have been able to manage its price stability quite well. However, this mechanism cannot be considered a very good strategy for pegging because we have seen many times in the digital currency market that the price of Tether has fallen below one dollar due to capital outflows, while the prices of digital currencies like USDC and BUSD have been on the rise.
For those who are among the large Tether (USDT) investors, long-term investment is entirely logical and profitable. However, on the other hand, this action has no benefit for small investors in the digital currency market. If you are a small-scale trader in the digital currency market, you should never buy Tether for long-term holding.
The performance of the digital currency Tether and analyses conducted by digital currency market participants indicate that Tether has a bright and promising future, and its impact on the digital currency market will undoubtedly increase in the future.
Digital currency DAI and Maker can be considered as stablecoins because even before the creation of stablecoins, these two digital currencies were traded as decentralized base currencies in the digital currency market. The support for the DAI digital currency was initially provided by the Ethereum digital currency, and at that time, the term “price peg” was only used for DAI when its lending rate fell below 150% of the collateral provided.
In such conditions, a liquidator could buy DAI digital currency and repay the loan, but this feature cannot be considered an advantage for users because only one tool was available, the lending rate based on DAI.
Months after Black Thursday, investors and traders in the crypto market had no interest in trading this currency because DAI was trading at a much higher price range than $1. Therefore, due to the lack of borrowers, no new model was created, and there was no arbitration to defend the DAI collection. At that time, the price of DAI did not exceed $1, which means that the pricing policies in this digital currency were effective, and market participants managed to manage the price peg of this digital currency well. However, this mechanism cannot be considered a very good strategy for pegging because we have seen many times in the digital currency market that the price of Tether (USDT) has fallen below $1 due to capital outflows, while the prices of digital currencies USDC and BUSD have increased during the same period.