What Is Algorithmic Stablecoin?

Fiat-backed stablecoins hold reserves against the tokens in circulation; algorithmic models instead try to protect the price with rules and incentives. One common method is a two-token structure: when the stablecoin rises above its target, new stablecoins are minted, and when it falls below, users can burn the stablecoin and receive the accompanying second token in return. Arbitrageurs taking advantage of these opportunities pushes the price toward the target. Some models use a rebase method that directly increases and decreases the balances in wallets.

The best-known example of this design is the UST stablecoin of the Terra network. Operating together with the LUNA token, UST lost its peg (depegged) in May 2022. Users rapidly exiting UST led to an excessive amount of LUNA being minted and the value of both assets collapsing; the event deeply affected the entire crypto market.

The core risk of algorithmic stablecoins is that when confidence is lost, the mechanism can turn into a self-reinforcing sell-off spiral (a death spiral). For this reason, many projects prefer hybrid models that combine algorithmic mechanisms with partial collateral or overcollateralized crypto reserves. Frameworks such as the European Union's MiCA regulation also impose reserve requirements on stablecoin issuers.