What is an Algorithmic stable coin? How it works and its types.

• Algorithmic stable coin in its purest form is not pegged to either off-chain or on-chain
• TerraUSD(USDT) and its sister token LUNA, collapsed

What is Algorithmic stablecoin –

Stablecoin coin holds its value from some other fiat currency such as the US Dollar. Traders trade in this because it is pegged by a stable value which makes them present in the crypto market and at the same time prevents them from market volatility.

The value of stablecoins is pegged to an asset whose value doesn’t fluctuate and guarantees the value of the stablecoin. Most major stablecoins USDC and Tether (USDT) are collateralized by the off-chain currency and some stablecoins are also backed by on-chain mechanisms like in the case of DAI. 

Algorithmic stable coin in its purest form is not pegged to either off-chain or on-chain rather than it is pegged to an algorithm – a specific set of rules or instructions that need to be followed by the computer to produce some result. These algorithms incentivize the market participants and manipulate the supply of coins to maintain their price around the peg.       

How does Algorithmic stablecoin work –

Algorithmic stable coin developers try to keep the value of its value stable by using various mechanisms. Unlike major stablecoins, the mechanism of algorithmic stablecoin is written on the protocol and is available publicly for general people to view. There are two common uncollateralized algorithmic stablecoin models –

Rebase –

rebase algorithmic stablecoin maintains the supply of coins in circulation to maintain the peg. In protocol, one can mint (add) or Burn(remove) from the circulation in proportion to maintain the value of the coin to pegged fiat currency($1). If the price is above $1, the protocol mints the coin and if the price is below $1 then it burns the coin. The coin minting and burning on the protocol is done in the coin holder’s wallet.

Seigniorage

– it is a multi-coin system, where stablecoin is pegged to more than one coin which includes one coin, that is stable and one other coin which facilitates this stability it is a combination of protocol-based mints-and-burns and free market mechanisms, it incentivizes its participants to buying and selling non-stable coin to push the value of the stablecoin to pegged.

The third model, the fractional-algorithmic model, is becoming more popular day by day. Part seigniorage, fractional algorithmic stablecoins aims to maintain their peg by collaborating best mechanism from “pure” uncollateralized stablecoin and their collateralized counterparts.