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What is Algorithmic Stablecoin?

Despite the fact that Terra LUNA fell by 99.47% in a single day and night last May, it turns out that this asset belongs to the stablecoin asset class. But which type of stablecoin? Accurate! TerraUSD (UST) is a crypto asset that falls under the algorithmic stablecoin classification.

Believe it or not, the algorithmic stablecoin itself is generally viewed as the best decentralized finance innovation (DeFi). This type of stablecoin is thought to be capable of committing to improving the way stablecoins work. The existence of transparent smart contracts allows the stablecoin asset class and other crypto assets to continue to sustain rapidly rising financial markets without requiring the participation of a central bank.

Initially, algorithmic stablecoins were created with the goal of maintaining price stability. How to? In particular, by actively keeping the supply of currency in circulation in conformity with market supply and demand. In reality, this type of crypto is not pegged to a reserve asset like the US dollar. This asset, on the other hand, employs an algorithm whose purpose is to issue more coins when the price rises and then buy it back as well as burn it when the price drops.

Three Different Types of Algorithmic Stablecoin

Algorithmic stablecoins are classified into three types: rebase, seigniorage, and fractional algorithmic. Each of these stablecoins employs a unique algorithm to maintain value.

a. Rebasing algorithmic stablecoin

This type of algorithmic stablecoin often manipulates the base supply to keep its peg. The protocol will mint or burn market circulation supply according to the deviation of the stablecoin price from US$1. If the price of the stablecoin exceeds US$1, the protocol will mint the coin. However, if the price of the stablecoin is less than one US dollar, the protocol will burn it. Ampleforth is an example of a rebase stablecoin type.

b. Seigniorage algorithmic stablecoin

The algorithm employed in seigniorage algorithmic stablecoins is a multi-coin system, in which the price of one stablecoin is designed to remain stable and at least one other coin is intended to maximize its stability. This strategy often combines a protocol-based mint-and-burn mechanism with a free-market mechanism that encourages market participants to buy or sell non-stablecoins in order to push stablecoin values toward the peg. Luna and UST from Terra Lab are two examples of this stablecoin type.

c. Fractional algorithmic stablecoin

Fractional algorithmic stablecoins combine the benefits of both fully algorithmic and fully collateralized stablecoins. Unlike a purely algorithmic design, this type aims to enforce somewhat tight pegs with a better level of stability. Frax is a fractional algorithmic stablecoin because it is partially backed by USD Coin, which is a stablecoin backed by the US dollar.