What are algorithmic stablecoins?
The term "algorithmic" might sound complex, but it essentially refers to a set of instructions coded into a process. For instance, the content displayed on your Facebook timeline is influenced by algorithms that consider factors like post relevance based on your past online activity. In the realm of cryptocurrency, an algorithm pertains to segments of code stored on the blockchain, typically implemented through smart contracts.
- Algorithmic stablecoins usually involve two types of tokens: a stablecoin and another cryptocurrency that supports the stablecoin. The algorithm, or smart contract, regulates the interaction between these two tokens.
Cryptocurrencies, like other assets such as real estate or stocks, experience fluctuations in value due to shifts in market demand and supply. This applies to stablecoins as well, as they are essentially cryptocurrencies traded openly on the market.
To prevent a stablecoin from deviating from its pegged value of $1 due to market conditions, algorithms manage supply and demand. For instance, when an asset is in high demand but there's limited supply, its price rises, and vice versa.
- The algorithm's purpose is to maintain stability.