Algorithmic Stablecoin is a variant of stablecoins. Algorithmic stablecoins are cryptocurrencies whose value is integrated into physical assets such as dollars and gold. One of the most well-known algorithmic stablecoins is Tether (USDT), and these assets provide their holders with price stability in the cryptocurrency market. Algorithmic stablecoins allow secure and low-cost access to the asset they are pegged to via blockchain. The price and circulating supply of algorithmic stablecoins are tracked simultaneously, helping to keep the price stable.
The first of the algorithmic stablecoins was Mastercoin, issued by J.R Willett in 2013. These assets have a code that is responsible for balancing supply and demand, providing scalability that other cryptocurrencies lack. Algorithmic stablecoins use an algorithm to stabilize the price. Algorithmic stablecoins utilize algorithms that can generate assets during price increases or buy them on the market during price decreases to stabilize their value. The algorithm ensures the price stability of stable cryptocurrencies.
Examples of algorithmic stablecoins include centralized assets such as Tether, BUSD, and USDC. These assets are considered the most suitable for the mass adoption of cryptocurrencies. Algorithmic stablecoins can protect against sudden price changes thanks to their instantly tradable algorithms.
Here are a few of the most popular algorithmic stablecoins:
- DefiDollar (DUSD)
- Empty Set Dollar (ESD)
- Frax (FRAX)
How Do Algorithmic Stablecoins Work?
Algorithmic stablecoins utilize many mechanisms to stabilize their prices. These mechanisms are recorded on the protocol and the information is publicly available on the blockchain. To prevent price spikes, algorithmic stablecoin values simultaneously track market conditions. Algorithmic stablecoins track the asset or derivative algorithms that they are integrated with. Algorithmic stablecoins utilize an Ethereum-based protocol that generates assets when the price rises and buys when the price falls.
There are three main models that algorithmic stablecoins use and they are as follows:
- Rebase
- Seniorage
- Fractional
Rebase
Rebase controls the circulating supply to maintain the price equilibrium of algorithmic stablecoins, and this algorithm burns or mints the circulating supply.
Seniorage
The Seniorage model aims to maintain price stability with the cryptocurrency being pegged if the value of an algorithmic stablecoin deviates.
Fractional
At its simplest, Fractional is a combination of Rebase and Seniorage models. Fractional uses reserves and smart contracts to stabilize the price of stablecoins.
What Are the Advantages of Algorithmic Stablecoins?
Algorithmic stablecoins are designed to avoid the price volatility of classic cryptocurrencies. Here are a few of the advantages of algorithmic stablecoins:
- Decentralization
- Automated Processing
- Low Cost
- Endurance to Volatility
Decentralization
Algorithmic stablecoins operate in a decentralized manner, meaning they are not linked to a central authority or organization.
Automated Processing
Algorithmic stablecoins use algorithms that are programmed to maintain price stability. With these algorithms, the price is stabilized automatically.
Low Cost
Algorithmic stablecoins can often have lower transaction costs than other assets, enabling people to own stablecoins at a lower cost.
Endurance to Volatility
Algorithmic stablecoins are endurance to market volatility.
What Are the Disadvantages of Algorithmic Stablecoins?
Algorithmic stablecoins offer many advantages but also some disadvantages. The disadvantages of algorithmic stablecoins are as follows:
- Increasing Supply
- Demand and Supply Balance
Increasing Supply
When the value of algorithmic stablecoins rises above a fixed price, the algorithms used automatically generate new digital assets to stabilize them.
Demand and Supply Balance
Algorithmic stablecoins are produced more to increase supply when demand rises, but the increase in supply may not happen as fast as the rise in demand. This can cause prices to spike and lead to a liquidity problem.
