Home Cryptocurrency Understand How Algorithmic StableCoins Work

Understand How Algorithmic StableCoins Work

by Blaze Eddie

Stable coins have been designed to protect traders from cryptocurrencies’ volatile nature. Usually, the coins are pegged 1:1 with some fiat currency. For example, if you buy USDT it is pegged with the US dollar. 1 USDT is equivalent to nearly $1. It ensures price stability. You can read more about cryptocurrencies on ZenGo X.

Different kinds of stablecoins are available and each one uses different techniques to maintain its hook with the fiat currency it tracks. Stablecoins have performed well in the emerging markets, where investors don’t have access to the dollar and their native fiat currency is volatile. Algorithmic stablecoin is an amalgamation of mathematics, monetary economics, and technology that represent the DeFi world.

For cryptocurrency trading, you need stability. Terra’s UST is the major algorithmic stable coin that wildly dipped by 90% and more within 24 hours. Its native LUNA token lost significant overall value. This situation has geared investors’ emotions towards fear. Their confidence due to market pressure is being verified on other stablecoins like sUSD, Neutrino, Frax, etc.

The Terra ecosystem went on a gigantic spiral, which had cast doubts on the algorithmic stablecoins efficacy and future in the cryptocurrency sector.

What are algorithmic stablecoins?

Stablecoins maintain a 1:1 peg with their fiat currency through the collateralized mechanism. It means stablecoins circulating around are supported by some asset or cash to support their valuation. For example, by market cap Tether [USDT] is the largest stable coin and is collateralized with fiat currency assets like USD cash] as well as cash-equivalent bonds that are stored in a centralized entity.

Sometimes, it is impossible to follow this method because protocols keep adding to their collateral supply because of an increase in stablecoin circulation. In this situation algorithmic stablecoins are helpful.

Algorithmic stablecoin functions a little differently. There is usually no collateral backing but uses complex algorithms to maintain a peg with tracking fiat currency. The algorithms incentivize and manipulate investors’ behavior to keep tracking coins’ value.

Algorithmic stablecoin types

  1. Rebase stablecoins – Manipulate the supply to maintain tracking fiat currency’s peg or connection. The protocol adds [mints] or removes [burns] stablecoins that are in line with fluctuations to keep their value stable. It means if stablecoin value falls below $1 they are cut off from circulation and vice versa.
  2. Seigniorage stablecoins – The working mechanism is the same but they even pair stablecoins with other cryptos to gain more control over their valuation. With the mint & burn tactic, the protocol even offers the investors an opportunity to buy or sell the paired cryptos and maintain stablecoin value.

Terra USD is an example of seigniorage stablecoin. Terra’s native cryptocurrency Luna is used to maintain its value with dollars. This pioneering pegging even led to its decline.

MATIC token maintains Polygon operations. It can be used to spend, hold, stake, or send cryptos. Buy Polygon on crypto exchange but you will need a safe platform to store the MATIC. An online wallet is a hardware or software device used to store the private and public keys needed to conduct crypto transactions.

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