What it is:
How it works (Example):
Let's say Country A has a tiny economy and an unstable government. As a result, the value of its is volatile. Company XYZ, which does business in Country A, wants to buy supplies from Company ABC, which is in Country B. Country B also has an unstable economy and an unstable currency.
Company ABC does not want to be paid in Country A's currency, so it proposes doing the deal with a key currency: the U.S. dollar. To do the transaction, Company A converts itsinto dollars and pays in dollars. Company B receives the dollars and converts them back into its home currency. Alternatively, the companies might just keep bank accounts that are denominated in dollars.
The central bank of countries A or B may even fix their currencies' exchange rates to the U.S. dollar so that other potential trading partners are more inclined to trade with them.
Why it Matters:
Key currencies help companies do business with less risk so their transactions won't be marred by sudden or extreme changes in values. Key currencies are also regarded as major global currencies. They usually include the U.S. dollar, the British pound, the euro, the yen and the Canadian dollar.