In this article, you will learn what are algorithmic stablecoins. Algorithms can be an obfuscating word. But it simply means a set of code that instructs a process. In crypto, an algorithm refers to pieces of code on the blockchain, as encoded in a set of smart contracts.
What are Stablecoins?
Cryptocurrencies are known for volatility; they can go up and down in double digits. But one form of cryptocurrency, called stablecoins, aims to provide refuge to those who want to exit constant volatility while still staying in the crypto market.
Stablecoins are cryptocurrencies that are supposed to be pegged to fiat currencies like the US dollar. In the cases of USD-pegged stablecoins, their prices are supposed to be $1 at all times.
Each stablecoin project differs in ways they maintain the peg. The two biggest ones, tether (USDT) and Circle's usd coin (USDC), are “over-collateralized” by fiat reserves, meaning they have cash or cash-equivalent assets in their reserves . So each USDT or USDC traded in the crypto market is backed by what's actually in the possession of the stablecoin issuers. Similarly, MakerDAO's stablecoin DAI is decentralized but also overcollateralized – backed by ether (ETH) deposited into its smart contracts.
What are Algorithmic Stablecoins?
Algorithmic stablecoins typically rely on two tokens – one stablecoin and another cryptocurrency that backs the stablecoins – and so the algorithm (or the smart contact) regulates the relationship between the two.
Cryptocurrencies – similar to all assets in the market, such as houses or stocks – move up and down in price depending on the market demand and the supply of the asset. This also includes stablecoins because they're essentially cryptocurrencies freely traded on the market.
To prevent the price of a stablecoin depegging – moving away from $1 – while subject to market conditions, algorithms regulate supply and demand. When there's too much demand for an asset but little supply of it, the price of that asset goes up – and vice versa. The algorithm's promise is to keep this in check, as we explore in the context of UST in the next section, before delving deeper into how that can go terribly wrong.
Types of Algorithmic Stablecoins
The outline of popular algorithmic stablecoins should always be associated with an overview of the types of algorithmic stablecoins. You can discover different algorithmic stablecoins with unique traits or features. Here is an outline of the distinct types of algorithmic stablecoins.
- Rebasing Algorithmic Stablecoins
The rebasing algorithmic stablecoins basically involve the supply taking over regulation of value. In this case, the algorithm reduces the coin supply in event of a price drop and ensures issuing additional coins in the opposite situation.
- Over-collateralized Algorithmic Stablecoins
The over-collateralized algorithmic stablecoins depend on a large reserve of cryptocurrencies for issuing lesser stablecoins. Such types of algorithmic stablecoins serve as an effective choice for a buffer for price fluctuations.
- Fractional Algorithmic Stablecoins
Fractional algorithmic stablecoins are one of the important additions to an algorithmic stablecoins list, and they are partially collateralized. The assets feature backing of cryptographic algorithms as well as asset collateralization.
- Seigniorage Algorithmic Stablecoins
The Seigniorage algorithmic stablecoin model opts for an alternative to the rebasing mechanism. It features two distinct tokens such as a supply-elastic currency and the investment shares of the network. The owners of the investment shares can receive inflationary rewards and bear the burden of when the currency falls.
Bottom Line
Algorithmic stablecoins are decentralized and focus on improving market price stability through pre-programmed supply for matching asset demand. So, if you want to know about algorithmic stablecoins, you can learn about what are algorithmic stablecoins.
