Cryptocurrencies have always been extremely volatile, owing to a variety of factors such as market conditions and supply-demand dynamics. Find out what algorithmic stablecoins are. Stablecoins have changed the game entirely by introducing a stable variant of cryptocurrencies.
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What are Algorithmic Stablecoins?
In their purest form, algorithmic stablecoins are completely uncollateralized. Their value is not backed by any external asset. Instead, they employ algorithms that contain specific instructions or rules that must be followed (typically by a computer) in order to produce a result.
These algorithms are designed to incentivize market participant behavior and/or manipulate circulating supply so that the price of any given coin should theoretically stabilize around the peg.
Why use a Stablecoin
Stablecoins began as a novel tool for traders to easily maintain the value of their digital assets. Converting cryptocurrency for fiat currency can be somewhat ambiguous. Therefore, a stable-value cryptocurrency was a quick and easy way for crypto traders to ensure price stability for their holdings.
However, the number of stablecoin use cases has grown significantly since then. People now create coins in association with several different reserve assets. They can link tokens to precious metals, real estate, and even other volatile digital currencies, in addition to fiat currencies.
You can check out this great article on How Stablecoins remain Stable.
As the number of use cases has continued to grow, so has the market capitalization of stablecoins. At the beginning of 2019, the total stablecoin market capitalization was roughly $2.6 billion. But as of this writing, the Stablecoin market according to coinmarketcap is a whopping $141.7 billion.🤑
How do Algorithmic Stablecoins work
The mechanisms of buying and selling the referenced assets are used by an algorithmic stablecoin to stabilize the market. It uses an Ethereum-based cryptocurrency protocol that issues coins when the price surges and buys them from the market when the price drops. The following is how algorithmic stablecoins operate:
An oracle contract is required to help the smart contract communicate outside the blockchain. This oracle contract helps in fetching the price of the algorithmic stablecoin from different exchanges.
This stablecoin price is then fed into a rebasing contract every 24 hours, which determines whether the supply needs to be increased or decreased.
The contract then starts tallying the number of tokens that need to be burned and minted from the wallets of every user associated with the contract. The basic logic used is that if the price of the coin increases from its predefined stable value, the algorithm will start burning the tokens. If the price of the token falls below a predetermined stable value, the algorithm will create new tokens.
Which Stablecoins are Algorithmic?
Here are some of the top lists of algorithmic stablecoins:
DAI is currently the first and foremost choice among algorithmic stablecoins. It is an Ethereum-based stablecoin among the algorithmic stablecoins currently available on the market. The Maker Protocol, in conjunction with the MakerDAO decentralized autonomous organization, plays an important role in issuing and developing DAI.
As a result, it fits the automated and decentralized model that is frequently associated with algorithmic stablecoins. The soft-pegging of the price of DAI against the US dollar is a clear advantage for users. At the same time, DAI is backed by collateral comprised of a variety of cryptocurrencies.
Consider Ampleforth to be one of the ideal decentralized stablecoins, leveraging a flexible supply to maintain price stability. It is an intriguing entry in the rebasing stablecoins category among popular algorithmic stablecoins.
The rebasing mechanism helps with regular adjustments in the supply of Ampleforth stablecoin. Thus, it can guarantee improved price stability in comparison to fixed-supply cryptocurrencies. Most important of all, the stablecoin of Ampleforth, AMPL, is completely non-dilutive and elastic.
DefiDollar aims to be a stablecoin index that uses DeFi primitives to stay close to the dollar while subsidizing the collateralization ratio to protect users from counterparty risk, holdings seizure risk, bank run risk, and so on. DefiDollar enables investors to index multiple stablecoins with a single token (DUSD), shielding users from the underlying risks associated with such tokens.
Empty Set Dollar
The Empty Set Dollar or ESD is another notable example among top algorithmic stablecoins offering the combination of multiple advantages. ESD promotes new protocol mechanisms, composability, and decentralization. As a result, it is a viable contender in the DeFi sector from an algorithmic stablecoins list.
ESD functions as a decentralized, oracle-focused stablecoin that effectively addresses the issues with algorithmic stablecoin rebasing through new protocol mechanisms. By using their tokens in dApps, token holders can avoid the need to actively maintain the price peg. In addition, you can also use it as a stablecoin without committing funds to a centralized provider.
The next popular entry among algorithmic stablecoin examples that can be better than TerraUSD includes Frax. As a matter of fact, the Frax Protocol is one of the first algorithmic stablecoin processes and systems. It operates as an open-source, permissionless cryptocurrency that exists entirely on the Ethereum blockchain.
The primary goal of the Frax protocol is to focus predominantly on highly decentralized, algorithmic, and scalable stablecoins. As one of the top algorithmic stablecoins, Frax looks forward to serving the DeFi money market. It can provide useful services such as minting and redeeming stablecoins in addition to staking. Interestingly, the Frax protocol uses two different stable assets, such as the Frax stablecoin, alongside the Frax Shares utility and governance tokens.
Algorithmic Stablecoins Types
There are three varieties of algorithmic stablecoins. The value of each kind is maintained using a distinct algorithm.
Rebasing Algorithmic Stablecoins
The supply controls the value of algorithmic stablecoins by rebasing them. The algorithm in a rebase mechanism automatically reduces the supply of coins when their price falls below a certain level and issues more coins when it increases. Due to this mechanism, the coin’s value is preserved regardless of market circumstances. The goal is to guarantee that, even if the number of tokens in your wallet fluctuates, if you own 1% of the supply prior to the rebase, you will still own 1% after it. This means that regardless of the native token’s price, you will always own a portion of the network.
Seigniorage Algorithmic Stablecoins
In the Seigniorage Algorithmic Stablecoin model, there are two tokens instead of a “rebasing” currency: a supply-elastic currency and investment shares of the network. Owners of the latter are the only recipients of inflationary benefits (from positive supply growth) and the only ones who bear the debt burden (when currency demand declines and the network shrinks).
Over-Collateralized Algorithmic Stablecoins
For the purpose of releasing fewer stablecoins, over-collateralized stablecoins require maintaining a sizable reserve of cryptocurrency tokens. To protect against price changes, this is done. MakerDAO’s DAI, which is collateralized with the ETH cryptocurrency, is an illustration of a stablecoin that is overly collateralized. This stablecoin requires a minimum of 150% of collateralization. This implies that the stablecoins will be automatically liquidated if the price of the underlying cryptocurrency falls to a certain level.
Fractional Algorithmic Stablecoins
Cryptographic algorithms and asset collateralization both support fractional algorithmic stablecoins, which are partially collateralized. This protocol uses two different assets, namely the Frax (FRAX) stablecoin (to maintain a 1:1 peg to the U.S. dollar) and the Frax Share (FXS) governance and utility token. A user can create FRAX by supplying the USDC stablecoin as collateral alongside the FXS token in the amount specified by the Frax collateral ratio (CR).
Stablecoins have previously been regarded as a new and safer type of cryptocurrency investment. Algorithmic stablecoins, however, are somewhat of an exception, as they rely on algorithms to hold their value steady.
The overview of which stablecoins are algorithmic shows the importance of leveraging new technologies for crypto adoption. Algorithmic stablecoins can provide users with a variety of value-added advantages as the use of stablecoins in DeFi grows.
Additionally, you can look for a variety of other alternatives among algorithmic stablecoins based on your unique needs. Most importantly, before making an investment, you must conduct extensive research on a particular algorithmic Stablecoin.