What is Algorithmic Stablecoin? Everything You Should Know
Algorithmic stablecoins are a relatively new type of cryptocurrency and are an alternative to centralized tokens such as Tether (USDT) or USD Coin (USDC).
The coin is based on a special algorithm to support the exchange rate. If the price rises, additional coins are issued; when it falls, the supply decreases.
Below, we will consider what kind of cryptocurrency an algorithmic stablecoin is, and how it works. We’ll highlight the main types and give you the top examples of each.
Have you heard about Utopia USD stablecoin? Learn more here.
What is an algorithmic stablecoin?
An algorithmic stablecoin is a cryptocurrency created to maintain the price and turnover at a certain level. The history of the coins began in 2013 when the first variants appeared on the Bitshare blockchain. The peculiarity of the cryptocurrency is its binding to fiat currencies, for example USD, or precious metals (most often gold). At the core of such coins is an algorithm that allows the project to increase the issue of coins when there is a price increase.
Stablecoins are used to hedge risks when investing in cryptocurrencies with high volatility. For example, you can include 30-40% of BTC and ETH in the investment portfolio, and fill the rest with algorithmic and classic stablecoins. The tool is characterized by low volatility and reliability.
How to buy Bitcoin anonymously. Read more here.
Features and operating principles of algorithmic stablecoins
Stablecoins are based on the algorithm rather than direct collateral and are in demand for the purpose of capital preservation. Cryptocurrencies work based on a smart contract that regulates the offer taking into account the market situation and a given program. Edits are made only when consensus is reached and by voting.
The principle of operation is based on an old model created back in 1517 and used by modern banks to regulate the exchange rate of domestic currencies. Against the background of the high volatility of other cryptocurrencies, stablecoins are gaining popularity.
Algorithmic money is based on a smart contract based on the ERC-20 standard and the Oracle system. The essence of the latter is to interact with information outside the blockchain system. In the process of using the Oracle blockchain, information about the price is received from several cryptocurrency exchanges.
Decentralized “assistants” can be used, determining the cost of a stablecoin, and transferring it to a smart contract for conversion. Based on the information received, the number of coins to be added or burned is determined.
The result is price control, which is typical only for algorithmic stablecoins. The absence of dependence on fiat money or other cryptocurrencies reduces the risks on the part of the user and makes such coins more reliable.
How to buy Monero anonymously. Learn more here.
Classification of algorithmic stablecoins
The types of algorithmic stablecoin can be divided into several categories:
- Rebased. The cryptocurrency is based on a conversion contract that works according to the principle discussed above. Price control occurs by changing the offer in the direction of increase/decrease. The changes apply to all wallets in which the cryptocurrency is located, and are proportional to the exchange rate.
- Fractional. This group includes fractional/secondary coins. They are 100% secured. A secondary tool is used to create it, and classic stablecoins (for example, USDC) play the role of partial support.
- Seigniorage. They imply price management through a system of creation and destruction with the direct participation of users. When analyzing the situation, the difference between the nominal price and the costs of its manufacture is taken into account.
In all cases, the main task remains to preserve the stability of cryptocurrencies:
- Without providing, for example, BAC or ESD.
- With collateral: full/partial: Frax or UST.
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Top Algorithmic Stablecoins
The reliability of stable cryptocurrencies based on the algorithm has led to an increase in demand from ordinary users. Below are the top such coins, considering their features, rate, and advantages.
A stablecoin from the Fractional category. It has a market capitalization of $2.6 billion and a trading volume of about 19 million per day. All coins in the amount of 2.69 billion are already in circulation.
Stablecoins are based on the dual structure of Frax and FXT tokens. The first is tied to the US currency, and the second belongs to the category of utilitarian cryptocurrencies used to create new coins.
The creation process starts when the exchange rate rises above $1. As a result, it is possible to maintain the cost at a fixed level and avoid serious exchange rate fluctuations. In addition, FTX can be used to store a price that has no collateral, and for Frax, a repurchase option is used.
Fei USD (FEI)
This algorithmic stablecoin is also part of the Seigniorage group. Its capitalization is $561 billion, and its daily turnover is about 6.7 million.
Fei USD (FEI) is a decentralized scalable DeFi protocol that provides a tight binding and preservation of the 1:1 ratio to the dollar.
The basis of the cryptocurrency contains only decentralized assets. The protocol feature allows other DAOs to maintain high liquidity in the credit/exchange markets. The value is based on the binding of the exchange of Fei USD (FEI) to Ethereum.
Ampleforth is an equally popular stablecoin with a capitalization of 96.8 million dollars. The daily turnover is about one million.
The AMPL cryptocurrency, like Bitcoin, has no collateral. Unlike BTC, it can be used to designate stable smart contracts.
The cryptocurrency is based on the Ampleforth protocol, which translates price volatility into supply fluctuations. This means that the supply increases or decreases taking into account the price. The information is updated every 24 hours, which ensures a steady course.
Algorithmic stablecoin advantages
But in favor of algorithmic stablecoins, there are several advantages that make such a tool promising:
- Anonymity. The use of stable cryptocurrencies based on algorithms cannot be associated with a specific person or company. This expands the possibilities for privacy.
- Ease of use. Users have at their disposal a large selection of platforms and tools that help in converting and withdrawing stablecoins into real money.
- A high degree of protection. Algorithmic stablecoins are completely secure, which is due to the use of a private key. The owner of such cryptocurrencies has access only to the associated money. Additionally, encryption services are available for storing and improving protection.
- Operations without mediation. The ability to conduct transactions without intermediaries is a key advantage of stablecoins. There are no limits and commissions related to the requirements of government agencies.
- Stability. Unlike volatile cryptocurrencies such as Bitcoin, Ethereum, and others, the exchange rate of algorithmic coins is adjusted taking into account the market situation.
- Decentralization. Stablecoins are not controlled by anyone, which reduces the risk of hacking and interference by intruders.
What is decentralization? Read more here.
In addition, stablecoins can be used as a means of exchange and a unit of account. Buying them allows you to save capital for a long time without the risk of volatility. An additional advantage is the ability to be used together with DApp. In addition, algorithmic coins are increasingly being used in matters of lending and loans.
What are the prospects?
The existing risks do not scare off market participants and make them increasingly look toward algorithmic stablecoins. The reason for this situation is the similarity of cryptocurrencies with Bitcoin, working on blockchain technology, but with a guarantee of stability. At the same time, the coin retains market demand for a long time.
The advantage is infinite scaling, which has led to the emergence of many types of stablecoins. At this stage, it has not yet been possible to create an ideal solution, but the very fact of searching and optimizing the system should lead to a result. The main “stumbling block” is the dependence of cryptocurrency on the trust of the market and its sections.
The weak point is the risk of attracting the interest of regulators who take control of centralized cryptocurrencies. Recently, a statement was made in the United States Senate about the need to link all stablecoins to fiat money. This creates risks for algorithmic cryptocurrencies, which are often not backed by anything or only partially backed up. With this in mind, questions arise about their prospects.