How “Algorithmic Stablecoins” Became the Latest Crypto Craze

Engineered Stability?

Throughout the first several months of 2022, digital assets known as “algorithmic stablecoins” began to grow in popularity. The broader term of “stablecoins” refers to cryptocurrencies that are linked to fiat money, often the US dollar. Issuers hold cash or bonds to ensure digital coins are backed by real assets, as measured in dollars.

Conversely, “algorithmic stablecoins” are not backed by assets, but remain linked to the dollar through financial engineering. By utilizing software and defined rules, the coin attempts to stay linked to the real asset’s price. The same algorithm aims to control the cryptocurrency’s level of circulating supply.

The Pros and Cons

Supporters of “algorithmic stablecoins” say they’re preferable to more traditional stablecoins because of their decentralized nature. Rather than a singular entity that oversees the assets’ link to the dollar, the algorithmic variety runs on its own, relying on traders across the world and adjusting its financial equation as coins are traded. Some investors say the algorithmic model is attractive because it has drawn less scrutiny from regulators, when compared to more traditional stablecoins.

Those who oppose algorithmic stablecoins argue they aren’t very stable at all. Some have experienced “global crypto runs” that overwhelmed the algorithm’s ability to keep the coin pegged to the dollar, effectively rendering it worthless. A notable example is Iron, an algorithmic stablecoin that collapsed last summer.

Most Popular Example

One of the world’s most popular algorithmic stablecoins is TerraUSD (UST), which was started in 2020. Since that time, its financial system has been largely successful in terms of maintaining its peg to the US dollar. One exception came around this time last year, when crypto was selling-off broadly. In May 2021, TerraUSD was worth closer to 92 cents.

The system is designed to keep things in balance and maintain the peg to one US dollar by offering investors the chance to “burn” TerraUSD depending on pricing. If one unit’s price falls below $1, traders can choose to eliminate or “burn” one of their coins for new units of a separate cryptocurrency, known as Luna. Alternatively, when TerraUSD’s price moves above $1, Luna units can be “burned” to move things in the opposite direction. As crypto grows and regulators look to respond, algorithmic stablecoins are becoming more well known, and sparking plenty of debate.

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