An algorithmic stablecoin is a type of cryptocurrency designed to maintain a stable value through the usage of an algorithm, such as the burn mechanism.
When the price of the stablecoin deviates from its target, the protocol automatically adjusts the supply—either by issuing new tokens or removing existing ones—to restore equilibrium. This mechanism aims to create a self-sustaining system that doesn’t rely on collateral but rather on market incentives.
While algorithmic stablecoins offer innovative approaches to achieving stability, they can also face challenges, particularly during market volatility, when maintaining their peg may become difficult.
Example
TerraUSD was an algorithmic stablecoin that stabilized the token price in the following ways. LUNA was the native token of the ecosystem.
- Over-valued: When the token price exceeded $1, more tokens were minted by burning LUNA. For each 1% increase in value, the token supply is increased by 1% of the circulating supply.
- Under-valued: When the token supply falls down from $1, a proportionate amount of UST was burnt and LUNA was minted.
