Exchanging Money

Whenever we travel to a country that uses a different currency, we have to exchange our local currency for theirs, but how are Exchange Rates set?

Exchange Rates

The Exchange rate is, simply put, the ratio of the value of two currencies. Here in the crypto space, we are always hearing about them, even if we don't notice it!

Example

When we say the price of Bitcoin is 50,000$, we are also saying that the Exchange Rate from BTC to USD is 50,000 and from USD to BTC is 1 / 50,000 (= 0.00002)

Pegging

Exchange Rates are usually set by the (relatively) Free Market, but sometimes certain currencies are pegged to other ones. For example, Panama has their currency, the Balboa, pegged to the US dollar at a rate of 1.0.
This means that Panama's Government will buy 1 Dollar for 1 Balboa and sell 1 Balboa for 1 Dollar.

How it works

The peg is maintained because, as a seller of Balboas on the Free Market, you will take no less that 1 Dollar for your Balboa and, as a buyer, you will pay no more than 1 Dollar for a Balboa. This is because you can always go to the Government and get a better price.

This holds while the Government has enough Dollars and Balboas to satisfy buyers and sellers. If too many people want Dollars, their reserves will deplete and the value of the Balboa will no longer be Pegged.

The benefits of Pegging

If a currency from a small country can be exchanged at a fixed ratio for USD, then it will be a LOT less volatile and will be more widely used by businesses and people, because they know they can exchange it for USD at any time.

Pegging in Crypto

And now, we have to ask, why would cryptos peg themselves to the Dollar?
Like we have seen, it will make those coins extremely more usable to businesses, because they don't incur the risk the the value of the crypto drops and erases their earnings. Theses are known as StableCoins.

Examples

USDT, or Tether is Tethered (Pegged, linked) to the US Dollar at a rate of 1.0, and as such has been widely used in business transactions and money sending for low fees. It's the 3rd largest currency by Market Cap (source)

Conclusion

Pegging is very useful when it comes to stability and confidence, which are essential for any crypto that wants to prioritize real-world usage, even at the cost of immense gains.

Thanks for reading!
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Reads about Money:

• The value of Money
• The Origins of Money