Algorithmic stablecoin

An algorithmic stablecoin tries to hold its peg, usually to the US dollar, through code and market incentives rather than by holding a full reserve of cash or other assets. Typically the system mints or burns a related token to expand or contract supply when the price drifts.

The best-known example is TerraUSD (UST). It kept its peg through a mechanism that let users always swap 1 UST for $1 worth of the Terra network's LUNA token. In May 2022, large withdrawals broke the peg and triggered a "death spiral": as UST fell, holders redeemed it for LUNA, flooding the market and crashing LUNA's price, which further undermined UST. Roughly $40 billion of value was wiped out within days.

After Terra's collapse, regulators and most investors became deeply sceptical of under-collateralised designs. Some newer stablecoins mix collateral and algorithmic mechanisms. Any stablecoin whose backing relies mainly on the value of its own sister token should be treated as high risk.