Fixing pegs

Access to fiat currency to pay certain expenses is important—most of a business' ultimate expenses are not going to be based on the price of Bitcoin or Ethereum, but the price of one or both of those currencies in US dollars or euros. Until you can pay for power and food in cryptocurrency, it's quite unlikely that the price of cryptocurrency in US dollars or euros will become irrelevant.

Some have heralded the development of a so-called stablecoin as the solution that would fix this problem. Various mechanisms can be used to ensure buying pressure or selling pressure in an asset, such as the backer buying back tokens when the value is below what was promised. Somewhat more simply, however, a token pegged to a currency issued by a sovereign government could be the solution.

A peg is a specific kind of fixed exchange rate system, in which the issuer of a currency asserts that their currency has a value based on that of another currency—and ideally is willing to exchange it for the same.

Economists tend not to speak of pegs favorably. The so-called tequila crisis in Mexico in 1994 is a famous example of a currency being overvalued. The Mexican government had issued bonds in pesos, which were redeemable in US dollars, at a valuation of about 3 pesos per dollar. It is doubtful that anyone believed the Mexican peso was worth that much. Eventually, short selling (borrowing the peso and selling it for dollars) and capital flight (investors unloading their peso-denominated assets) led to a precipitous drop in the value of the peso, and then to a severe recession.

Mexico's central bank attempted to control inflation by raising interest rates. Unlike the US and continental Europe, many mortgages in Mexico were adjustable rate, which meant that interest as a proportion of a homeowner's payment went up drastically, leading in many cases to default and foreclosure.

A handful of countries, such as Cambodia, do continue to use pegs in spite of their downsides, but it's difficult to find many other things so widely regarded as a bad idea.

Attempts to peg cryptocurrency to US dollars invariably raise money in cryptocurrency and then use it to buy sovereign debt. The assertion is that one unit of the token is equal to a dollar, or some fraction of a dollar. The tokens are backed by the debt held by the issuer, and in theory, the issuer is able to make money on the float.

If the issuer tries to minimize risk and only buys treasury bills at 1-3%—well, 1-3% of a few billion dollars is probably enough to pay your staff. The business model is pretty straightforward. PayPal famously also attempted to go fee-free and pay all of their expenses out of the float—and didn't succeed.

The most famous attempt at a stablecoin is Tether (Ticker: USDT), the price of which hovers around $1. Tether retained Friedman LLP, a New York accounting firm, and promised regular audits. These audits didn't materialize, and Friedman (likely owing to respect for the interests of the principal) has not made any statements concerning the validity of Tether's claim that each unit is backed by cash or a cash equivalent.

A peg of this nature would be a little odd in the cryptospace; ultimately underlying this sort of transaction is trust. It is almost antithetical to the idea of a trustless, decentralized ecosystem; but an alternative exists.