How an algorithmic stablecoin works
A protocol, a set of smart contracts, targets a price, usually one US dollar. When the token trades above the target the protocol creates more of it, and when it trades below, the protocol removes supply or pays holders to lock tokens away.
Many designs pair the stablecoin with a second token that absorbs the swings. TerraUSD could be converted into one dollar's worth of its sister token Luna, and the other way round, so arbitrage was meant to pull the price back to one dollar.
Why algorithmic pegs fail
The second token has value only while people expect the system to grow. Once holders doubt it, redemptions create more of that token, its price falls, and each further redemption needs still more: a run that feeds itself.
The Bank for International Settlements describes TerraUSD's value dropping from one dollar to a few cents over a few days in May 2022.
What EU law says about algorithmic stablecoins
Algorithmic stablecoin is a market term, not a legal category. Recital 41 of MiCA says that its rules for asset-referenced tokens and e-money tokens apply whatever mechanism keeps the value stable, and names so-called algorithmic stablecoins that aim at a stable value against an official currency or other assets.
A platform that lists or accepts a stablecoin therefore asks first which category the token falls in and who its issuer is.
Algorithmic or collateralised?
- Fiat-backed stablecoin
- The issuer holds reserves in the token's currency and redeems on request. The peg rests on assets, not on a mechanism.
- Crypto-collateralised stablecoin
- Also run by smart contracts, but each token is backed by other crypto-assets worth more than the tokens issued.
Where an algorithmic stablecoin shows up in a platform
Modules that do the work
- Custody & walletsWallets on every major chain, with MPC custody from leading providers or your own keys.
- CheckoutA hosted checkout for cards, wallets, bank payments and crypto, routed to the best provider.
Platforms that need it
Where it is written
The laws and standards this page's facts come from.
- Regulation (EU) 2023/1114, MiCA, recital 41 (EUR-Lex)
- BIS, Annual Economic Report 2022, chapter III, The future monetary system, 26 June 2022
General information, not legal advice: what applies to you depends on your services and your market.