What is Hard Peg?

Hard Peg is an exchange rate policy in which there’s a fixed exchange rate between two currencies. For instance, when China fixed its Chinese Yuan to the US dollar at the rate of 8.28 per dollar.

If one currency has a fixed exchange rate to another currency or a basket of currencies, that currency’s value will fluctuate with the same ratio against other currencies. There’s only so much movement allowed in relation to a pegged currency when a hard peg is established. This creates a currency band.

A lot of currencies have a fixed exchange rate in the beginning, however as more time passes by, they start to move freely based on the market conditions. Generally speaking, it happens since the government can’t or won’t maintain the peg due to various reasons. 

For example, Tether (formerly known as RealCoin) states that its cryptocurrency is pegged to the US dollar. Therefore, one unit of their tokens is backed by one US dollar which is held as a reserve by Tether Limited. It’s unknown whether there are any solid grounds behind these claims.

Transparency and simplicity are the key benefits of hard pegs since the supply of cryptocurrency is fixed and well-known. This can make them a lot easier to apply while maintaining transaction anonymity.

One of the few drawbacks of a hard peg is problems maintaining a peg in cases where people would rather use their reserves as a currency instead of a commodity. For instance, if a large number of people were to buy Tether’s cryptocurrency, they wouldn't be able to back every issued token since there will be a shortage of dollars.

If more and more people were to start selling their cryptocurrency for dollars, peg maintenance would become quite challenging. 

When a country fixes its currency’s value to the value of another country’s currency, it’s enforcing the hard peg policy. Usually, countries that experience high amounts of trade enforce this type of policy such as nations in East Asia. 

Moreover, a hard peg can also be enforced due to an agreement between many countries to peg each other’s currencies. An example of this would be the European Union. 

There can be many benefits of pegging currencies between different countries.

Firstly, hard pegs offer countries stability by establishing an exchange rate and eliminating any doubts about money supply fluctuations. It’s a great option for developing countries.

Secondly, hard pegs create a space for easy trading with other countries that have fixed their currency with each other. This way countries don’t have to devalue their currencies in order to get better trade terms.

Thirdly, stabilizing the exchange rates disables fluctuations in its money supply. Thus minimizing the risk of foreign investors taking loans and capital investments in that specific country.