An algorithmic stablecoin is a type of cryptocurrency that is designed to maintain a stable price by using an algorithmic mechanism to control its supply. Unlike traditional cryptocurrencies, such as Bitcoin, whose value can be highly volatile, stablecoins aim to provide a more stable store of value that can be used for transactions or as a store of wealth.
Algorithmic stablecoins achieve price stability by adjusting the supply of the coin in response to changes in demand. For example, if the price of the stablecoin starts to rise above its target value, the algorithm would increase the supply of the coin, which would in turn bring the price back down. Conversely, if the price starts to fall below its target value, the algorithm would decrease the supply of the coin, which would increase demand and bring the price back up.
Algorithmic stablecoins can be backed by a variety of assets, including other cryptocurrencies, fiat currencies, or even commodities like gold or oil. However, some algorithmic stablecoins are not backed by any underlying asset, but instead rely solely on the algorithmic mechanism to maintain their price stability. These are known as non-collateralized or algorithmic stablecoins.
Classical examples for non-collaterized algorithmic stablecoins are:
- Ampleforth (AMPL) - Ampleforth uses an elastic supply mechanism to maintain price stability. When the price of AMPL rises above its target value, the supply of AMPL increases. Conversely, when the price of AMPL falls below its target value, the supply of AMPL decreases.
- Empty Set Dollar (ESD) - Empty Set Dollar uses a "bonding curve" mechanism to maintain price stability. When the price of ESD rises above its target value, users can mint new ESD by purchasing bonds. When the price of ESD falls below its target value, users can redeem their bonds for ESD, which reduces the supply of ESD in circulation.
- Frax (FRAX) - Frax uses a "fractional-algorithmic" mechanism to maintain price stability. FRAX is partially backed by USDC, but also uses an algorithmic mechanism to adjust the supply of the coin in response to changes in demand.
It's important to note that non-collateralized algorithmic stablecoins can still be volatile, as their price is dependent on the accuracy and effectiveness of their algorithmic mechanisms.