"What is the difference between an algorithmic stable coin and a collateralized one?"
#JeremyAnswers
Background:
A stable coin is a type of cryptocurrency which attempts to keep it's value equal to the value of another asset, this is known as "pegging".
Stable coins are most commonly pegged to fiat currency, e.g. UST, USDT, DAI, BUSD, AUDT etc.
A collateralized stable coin's pegging mechanism works by adjusting token supply depending on the value of assets in a reserve. Tokens are minted when assets are deposited and vice versa.
USDT is a collateralized stable coin pegged to USD. It's reserves look like:
Algorithmic stable coins don't hold collateral. They use algorithms to peg the value of the token to an asset instead.
A simple example:
- Increase token supply when token value too high.
- Decrease token supply when token value too low.
Stability is the most important factor of a stable coin.
De-pegging leads to lost confidence, which leads to sell-offs, which introduces more instability, which further exacerbates de-pegging.
When it starts to spiral it gets harder and harder to correct.
UST is an algorithmic stable coin that is in a lot of trouble right now. It de-pegged on the 8th May and has been struggling to re-peg ever since.
UST's mechanism which improves stability by incentivising arbitrage isn't working.
Blog post 👇
isitlegit.substack.com/p/the-ust-de-peg?r=18n6pb&s=w&utm_campaign=post&utm_medium=web