What is a Currency Peg?

Well, yes, and no!

This is where currency pegging comes in:

Currency pegging is when a country attaches, or pegs, its exchange rate to another currency, or basket of currencies, or another measure of value, such as gold. Pegging is sometimes referred to as a fixed exchange rate. A currency peg is primarily used to provide stability to a currency by attaching its value, in a predetermined ratio, to a different and more stable currency.

Quite often, governments of smaller countries peg their currencies to the currency of a bigger country. But this “pegging business” does not stop here!

When a new commercial bank starts to operate, in reality, a brand new digital currency is being created (that is: customers’ accounts at the bank). When the bank approves a loan, fresh new tokens of the bank’s digital currency are being issued in circulation. With tens of thousands of commercial banks operating, how come this does not turn into a complete mess?

You probably know the answer to this question already: Every commercial bank pegs its digital currency to the currency issued by the central bank of the country. The digital currency issued by the central bank is called bank reserves.

Bank reserves are the cash minimums that financial institutions must have on hand in order to meet central bank requirements. This is real paper money that must be kept by the bank in a vault on-site or held in its account at the central bank. Cash reserves requirements are intended to ensure that every bank can meet any large and unexpected demand for withdrawals.

When somebody transfers money from an account in one commercial bank, to an account in another commercial bank, in reality, several “invisible” exchanges happen:

1. The sender’s bank “sells” some amount of its bank reserves to the central bank.

2. The central bank increases the bank reserves held by the recipient’s bank, and instructs the bank to deposit the same amount of recipient’s bank digital currency to the recipient’s account.

3. If the bank reserves held by the sender’s bank fall below the required minimum, the bank can sell some of its assets (bonds, mortgages, etc.) to the central bank, and in exchange, obtain the needed bank reserves.

So, on closer inspection, one realizes that what looks like a single physical (paper) currency, in reality, is a tree of digital currencies held together by currency pegs:

The above tree of currency pegs shows only issuers of digital currencies that are regulated by the banking law. But again, the “pegging business” does not stop here!

Every non-banking institution that issues IOUs, which can be traded on some market, in reality, issues a currency (digital or not). Most of these non-banking currencies are also pegged to the national currency.

Bonds are the most obvious example. Bonds can be issued by governments, municipalities, or corporations. They are traded on specialized markets, where most of the buyers and sellers are banks, or other big financial institutions. Every bond has a face value, which is a fixed exchange rate to the national currency, declared by the issuer of the bond. In theory, the amount that bond issuers can issue is unlimited. In practice, the amount is limited by the availability of bond buyers.

Now, getting back to the original question:

Well, I do not know! I guess history will be the judge. But what I know is that lots of big, and not so big players, have been doing this for hundreds for years, and the “game” is much less regulated than commonly perceived. Occasionally, this turns into to a mess. But most of the time, it seems to work quite well.

Currency Pegging in Swaptacular

Currency pegging is a first-class citizen in Swaptacular. When you configure your own currency, you can specify a fixed exchange rate with some other Swaptacular currency. Non-Swaptacular currencies (USD, EUR, gold etc.) can also be used as pegs, if global currency IDs have been reserved for them.

In practice, this means that almost all of the currencies created in Swaptacular will be denominated in well known currency units (USD, EUR, gold), and will not even have their own name, apart from the name of the issuer. Precisely for this reason, in Swaptacular currency issuers are called debtors, and currency holders are called creditors.

Currency Exchanges in Swaptacular

Remember the example I gave earlier, when somebody wanted to transfer money from an account in one commercial bank, to an account in another commercial bank? It turned out, because every commercial bank, in reality, issues its own digital currency, the amount first had to be exchanged to bank reserves. (That is, the digital currency issued by the central bank.)

Well, it is nearly the same in Swaptacular! You can use a currency that you have, and swap it with a currency that you need. Remember, as long as both currencies are part of the same tree of currency pegs, such an exchange can be performed more or less automatically, because the exchange rate is fixed and well known.

In practice, performing automatic exchanges between gazillion of currencies is not an easy task. One proven strategy is to have specialized currency exchange hubs, which operate for profit. Another promising strategy is to implement automatic currency exchanges in the spirit of Circular Multilateral Barter.

Allowing automatic currency exchanges in Swaptacular has been a key goal since the beginning. All the underlying protocols are designed to support it, and I hope that in the not so distant future, we will have the time and resources to implement it.