What Is Hard Peg?
Hard Peg is an exchange rate policy, where a currency is set at a fixed rate against another currency.
For example, the Chinese Yuan was pegged to the U.S. dollar at a fixed rate of 8.28 per dollar.
The fact that a currency's value is pegged to another currency or basket of currencies means that it will fluctuate against other currencies with the same ratio. A hard peg only allows for a certain amount of movement in relation to the pegged currency, creating what's called a band.
Currencies often start out with a fixed exchange rate, but in time they're allowed to float freely as market conditions dictate. That typically happens because the government no longer wants to maintain the peg due to economic or political reasons—or simply because it can't continue supporting it.
Tether is one example of a cryptocurrency pegged to the US dollar. It was first launched as RealCoin and later was renamed Tether. The Tether company claims that each unit of the token is backed by 1 US dollar held in reserve by Tether Limited, but this has been disputed.
An advantage of hard pegs is that they are simple and transparent: the supply of the cryptocurrency is fixed and known. This may make them easier to implement without breaking the anonymity of transactions.
A disadvantage of a hard peg is that it can be challenging to maintain a peg if people want to use their holdings as an actual currency rather than a commodity. For example, if too many people buy the currency, there won't be enough dollars held in reserve to back all issued Tethers.
If too many people sell their holdings for dollars, maintaining the peg would also become difficult.
Currency pegging is a practice in which countries fix the value of their currency to that of another country. Pegging generally happens where a lot of trade occurs, like in East Asia. It can also happen at the global level when a group of countries, such as the European Union, agree to peg their currencies with each other.
Tying a currency to the value of another country's currency can be advantageous in several ways:
1. Stability. By fixing its currency value, a country effectively locks in an exchange rate and eliminates uncertainty about fluctuations in its money supply. This is especially attractive for developing countries.
2. Effortless trade with other fixed-rate countries. If a country fixes its currency relative to another one, it doesn't have to worry about devaluing its own money if it wants to get better trade terms with the other country; it already has those terms by having fixed its currency with the other country's.
3. Lowering risk on capital investments and loans. By keeping exchange rates stable, countries eliminate the risk associated with fluctuating rates and make their money supplies more predictable for businesses looking to invest or borrow money in that country or region.
