🧵Algorithmic stablecoins, a revolution in crypto?
Unlike traditional stablecoins backed by reserves of assets, algorithmic stablecoins use automated mechanisms to keep their value stable. They do not require physical collateral such as gold or fiat currencies.
2/8 - How do algorithmic stablecoins work?
These stablecoins automatically adjust their supply based on price fluctuations. When their price exceeds the target, the algorithm creates more tokens. When the price drops, the tokens are burned to reduce the supply.
3/8 - Maintain parity with the dollar
The algorithm constantly monitors the price of the stablecoin relative to the asset it is backed by, often the dollar. By adjusting the token supply, the price is kept around $1.
4/8 - Example: TerraUSD and Luna
The TerraUSD project used the Luna token to balance its price. When TerraUSD exceeded $1, more Luna were created, and vice versa. But the failure of this project revealed the risks of this model.
5/8 - Advantages of algorithmic stablecoins
They are often more decentralized, not relying on a central authority to manage reserves. Their supply adjustment mechanism via smart contracts makes them accessible to a global audience.
6/8 - The major challenges
Algorithmic stablecoins can lose their anchor during periods of high volatility. Their complex algorithms can fail to stabilize prices, as was the case with TerraUSD in 2022.
7/8 - Frax, a hybrid model
Frax is a partially collateralized algorithmic stablecoin, combining a reserve of assets and an algorithmic mechanism to maintain stability. This aims to reduce the risks of undercollateralization.
8/8 - Conclusion
Algorithmic stablecoins are a promising innovation, but they come with risks related to volatility and the complexity of their mechanisms. However, they offer a more decentralized option for users looking for alternatives to traditional stablecoins.
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