ALGORITHMIC STABLECOIN UNVEILS NEW WAYS TO PRESERVE ITS PEG TO US DOLLAR

Last updated: June 20, 2025, 00:26 | Written by: Brian Kelly

The world of cryptocurrency is constantly evolving, and one of the most intriguing developments is the rise of algorithmic stablecoins.These digital assets aim to maintain a stable value, typically pegged to a fiat currency like the U.S. dollar, but unlike traditional stablecoins backed by reserves, they rely on sophisticated algorithms and smart contracts.The spectacular collapse of TerraUSD (UST) in 2025 cast a long shadow over the entire sector, leading to widespread skepticism about the viability of algorithmic stablecoins. The latter purported to be a partially collateralized stablecoin, backed by TITAN and another stablecoin USDC USDC, issued by crypto payments company Circle and digital assets exchange CoinbaseThis event prompted developers to explore new and innovative mechanisms to maintain their peg and avoid the dreaded ""depeg,"" where a stablecoin loses its intended value. Counterparty performance is relevant as any financial, operational, legal or regulatory issues the counterparty responsible for the stablecoin s peg has may negatively impact the ability to preserve the peg. For centralized stablecoins minted by an issuing entity that also has control of the reserves, insolvency or fraud could result inThe challenge? Algorithmic stablecoin unveils new ways to preserve its peg to US dollar to avoid a depeg from the U.S. dollar. If you recall, much of UST's woes began when the value of this digitalTo create a system robust enough to withstand market volatility and user panic. When a stablecoin deviates from its peg due to market turbulence, lack of liquidity, regulatory issues or technological issues traders and investors react by buying or selling the stablecoin. This can create arbitrage opportunities, whereby the trader might try to sell the stablecoin and purchase the underlying asset if the stablecoin sAs the algorithmic stablecoin sector tries to rebuild, we examine cutting-edge methods that these projects are using to regain trust and secure their stability.

Understanding Algorithmic Stablecoins

Algorithmic stablecoins represent a departure from traditional stablecoins like Tether (USDT) and USD Coin (USDC), which are backed by reserves of fiat currency or other assets. Algorithmic stablecoins are a type of cryptocurrency designed to preserve a stable value, normally pegged to a currency much like the dollar (US). Unlike traditional stablecoins which is probably sponsored with the help of the usage of assets like coins or crypto reserves, algorithmic stablecoins achieve stability through smart algorithms.Instead of relying on collateral, algorithmic stablecoins use algorithms to adjust their supply in response to changes in demand.If the price rises above its peg, the algorithm increases the supply, lowering the price. Stablecoins employ asset backing and algorithmic controls to maintain their peg to fiat currencies, commodities, or other cryptocurrencies. Asset-backed stablecoins are anchored by tangible or digital reserves, providing a direct correlation between the stablecoin s value and its underlying assets for trust and reliability.Conversely, if the price falls below its peg, the algorithm decreases the supply, increasing the price. A common feature is a set relationship to a second crypto-asset token, wherein trading between the stablecoin and second token is intended to provide arbitrageurs profitable opportunities to return the stablecoin to its peg. However, the algorithm fails if both the stablecoin and the crypto-asset token simultaneously drop in price, resulting inThis is the core principle guiding their attempts to maintain a stable value.

How do Algorithmic Stablecoins Work?

The mechanics of algorithmic stablecoins can vary significantly, but they generally involve smart contracts that automatically adjust the coin's supply based on its price relative to the target peg. Frax is a fractional algorithmic stablecoin, which is partially backed by collateral and partially stabilized by algorithms. The ratio between collateral and algorithm adjusts over time to ensure price stability. TerraUSD (UST) Once a prominent algorithmic stablecoin, UST used a dual-token system with LUNA to maintain its peg to the US dollar.Here's a breakdown of common approaches:

Rebase Mechanisms: These algorithmic stablecoins, like Ampleforth (AMPL), adjust the supply of the coin proportionally across all holders.If the price is above the peg, the supply increases, and everyone's holdings are proportionally increased.If the price is below the peg, the supply decreases, and everyone's holdings are proportionally decreased.
Seigniorage (Dual-Token) Systems: These systems, like Basis Cash (BAC), use a second token (the ""bond token"") to incentivize users to help maintain the peg. On the Solana blockchain, UXD is an algorithmic stablecoin backed 100 percent by a delta neutral position. Ampleforth (AMPL) It is a rebasing algorithmic stablecoin that is tied to the CPI-adjusted 2025 USD. Basis Cash (BAC) The stablecoin Basis Cash (BAC) uses a three-token seigniorage method to keep its 1 USD peg by using shares and bonds.When the stablecoin's price is above the peg, new stablecoins are minted, and the bond token is used to absorb the excess supply. These decentralized stablecoins tie their value to an asset like the U.S. Dollar. In other words, an algorithmic stablecoin may hold its price at a dollar. If the price of the coin rises, then they use algorithms that can mint more coins (lower demand/increase supply) to drop the price back to a dollar.When the price is below the peg, bond tokens are sold to buy back and burn stablecoins.
Fractional-Algorithmic Models: These systems, like Frax, combine collateralization with algorithmic mechanisms. Ampleforth (AMPL) is a standout example of a rebasing stablecoin. Unlike traditional stablecoins, which are backed by collateral, Ampleforth uses an innovative approach to maintain its peg. Every day, the supply of AMPL is adjusted based on its price deviation from a target, typically $1.A percentage of the stablecoin is backed by collateral (e.g., USDC), while the remainder is stabilized by algorithmic adjustments. This algorithmic stablecoin believes it offers a higher degree of robustness (Sponsored) There are harsh lessons to learn after the collapse of UST. Cointelegraph - There are harsh lessons to learn after theThe ratio between collateral and algorithm changes dynamically based on market conditions.

Smart contracts play a crucial role in automating these supply adjustments, ensuring that the system operates according to pre-defined rules. A seigniorage (or dual-token) algorithmic stablecoin usually relies on two tokens: the stablecoin itself, and a second one called the bond token. Together, these two tokens work to maintain price stability via market incentives. When the stablecoin trades above a dollar, it suggests that demand outpaces supply. The protocol rectifies this byThese smart contracts are designed to be transparent and immutable, providing users with confidence in the system's integrity.

New Strategies for Peg Preservation

The collapse of UST exposed the vulnerabilities of purely algorithmic approaches. Until 2025, TerraUSD (UST) was the largest algorithmic stablecoin in the industry with a market capitalization of $18.7 billion as of May 5 2025. The stablecoin lost its algorithmic price peg to the US dollar following a wave of panic selling that saw the TerraUSD s price readjust to $0.01.Newer projects are incorporating innovative strategies to enhance their resilience and strengthen their peg to the US dollar. An infamous example of an algorithmic stablecoin was TerraUSD (UST), which attempted to maintain its peg to the US dollar using an automated system of supply adjustments. Benefits Decentralization: Algorithmic stablecoins bypass the need for a central authority or reserve, offering complete decentralization.These strategies focus on diversifying collateral, improving algorithmic designs, and building robust risk management systems.

Diversifying Collateral

One key lesson from the UST collapse is the importance of having sufficient and diverse collateral.Relying solely on a volatile sister token, as UST did with LUNA, creates a significant risk of a ""death spiral,"" where the value of both tokens collapses simultaneously.Newer algorithmic stablecoins are focusing on:

Multi-Collateral Backing: Instead of relying on a single asset, these stablecoins are backed by a basket of assets, including stablecoins (USDC, DAI), cryptocurrencies (Bitcoin, Ethereum), and even real-world assets (tokenized securities). Example: TerraUSD (UST) was an algorithmic stablecoin that attempted to maintain its peg to the US dollar using a mint-and-burn mechanism with its sister token, LUNA. However, due to its design flaws and market vulnerabilities, UST lost its peg in May 2025, leading to the collapse of both UST and LUNA.This diversification reduces the risk of a single asset's volatility impacting the stablecoin's peg.
Over-Collateralization: Some projects are over-collateralizing their stablecoins, meaning that the value of the collateral exceeds the value of the stablecoins in circulation. There are many different types of stablecoins. USDC, for example, is a stablecoin tied to the US dollar. It s fully backed by cash and cash-equivalent assets for 1:1 redeemability with US dollars. Stablecoins are reshaping the global financial landscape, promoting financial inclusion, and establishing a new era of global finance.This provides a buffer against market fluctuations and reduces the risk of a depeg.
Transparent Reserve Management: Regular audits and transparent reporting of the collateral held in reserve are crucial for building trust and confidence among users. For instance, if a stablecoin's value falls below $1, new coins may be burned to decrease supply, increasing demand and driving the price back to the desired peg. Smart contracts play an essential role in maintaining pegs.This allows users to verify that the stablecoin is adequately backed and that the reserves are being managed responsibly.

Improving Algorithmic Designs

Beyond collateralization, algorithmic stablecoins are also evolving their algorithmic mechanisms to be more robust and responsive to market conditions:

Dynamic Supply Adjustments: Instead of relying on fixed supply adjustment rules, some algorithms are designed to adapt to changing market conditions.They might adjust the magnitude and frequency of supply adjustments based on factors like trading volume, volatility, and market sentiment.
Circuit Breakers: Circuit breakers are mechanisms that halt or slow down supply adjustments during periods of extreme market volatility. Launched in 2025, Ampleforth was the first-generation algorithmic stablecoin. Its mission isn t simply being as close to $1 as possible Ampleforth is meant to be an asset not exposedThis prevents the algorithm from overreacting to temporary price fluctuations and potentially exacerbating a depeg.
Oracle Integration: Reliable price feeds are essential for algorithmic stablecoins to function effectively. Ripple, the leading provider of enterprise blockchain and crypto solutions, announced its plans to launch a stablecoin, pegged 1:1 to the US dollar (USD). Ripple s stablecoin will be 100% backed by US dollar deposits, short-term US government treasuries, and other cash equivalents. These reserve assets will be audited by a third-partyProjects are integrating multiple oracle providers to ensure that the price data used by the algorithm is accurate and resistant to manipulation.

Enhanced Risk Management

Effective risk management is paramount for algorithmic stablecoins to maintain their stability over the long term.This includes:

Stress Testing: Rigorous stress testing simulates extreme market conditions to identify potential vulnerabilities in the algorithm and the collateral. The stunning crash of UST stablecoin and LUNA, its sister token, has many questioning if an algorithmic stablecoin can be trusted. Por Ekin Gen Actualizado, 4:47 p.m.This helps developers understand how the stablecoin would perform under various scenarios and make necessary adjustments.
Governance Mechanisms: Decentralized governance mechanisms allow the community to participate in the management of the stablecoin, including decisions about collateral, algorithm parameters, and risk management policies.This can help ensure that the stablecoin is managed in a way that aligns with the interests of its users.
Emergency Protocols: Having clearly defined emergency protocols in place is essential for responding to unexpected events that could threaten the stability of the stablecoin.These protocols might include temporarily halting minting and burning, adjusting collateral ratios, or even temporarily suspending trading.

Examples of Algorithmic Stablecoins and Their Approaches

Several algorithmic stablecoin projects are experimenting with these new strategies. UST: An algorithmic stablecoin tragedy. UST was perhaps the most well-known algorithmic stablecoin, developed by the Terra blockchain. UST maintained its peg to the US dollar through a mint-and-burn mechanism involving another cryptocurrency, a governance token called LUNA.Here are a few examples:

UXD (on Solana): This algorithmic stablecoin is backed 100% by a delta-neutral position on the Solana blockchain.This means it uses derivatives to hedge against price movements in the underlying asset, aiming for stability.
Frax: As mentioned earlier, Frax is a fractional-algorithmic stablecoin that combines collateralization with algorithmic mechanisms.Its ratio between collateral and algorithm dynamically adjusts over time to ensure price stability.
Ampleforth (AMPL): A first-generation rebasing stablecoin, AMPL adjusts the supply of tokens held by each user daily to target a specific price.While not pegged directly to USD in the traditional sense, it aims to provide a stable, uncorrelated asset.

The Role of Counterparty Risk

Even with sophisticated algorithms and diversified collateral, counterparty risk remains a significant concern for algorithmic stablecoins.This refers to the risk that a third party involved in the stablecoin's ecosystem could default on its obligations, leading to a depeg.Examples of counterparty risks include:

Custodial Risks: If the collateral backing the stablecoin is held by a custodian, there is a risk that the custodian could become insolvent or engage in fraudulent activities.
Oracle Risks: Algorithmic stablecoins rely on oracles to provide accurate price data.If an oracle is compromised or provides inaccurate data, it could lead to incorrect supply adjustments and a depeg.
Smart Contract Risks: Smart contracts are complex pieces of code, and there is always a risk that they could contain bugs or vulnerabilities that could be exploited.

To mitigate counterparty risk, algorithmic stablecoin projects are implementing various measures, including:

Decentralized Custody: Using decentralized custody solutions, such as multi-signature wallets, can reduce the risk of a single point of failure.
Multiple Oracle Providers: Integrating multiple oracle providers can reduce the risk of relying on a single oracle that could be compromised.
Formal Verification: Formal verification is a rigorous process of mathematically proving that a smart contract is correct and secure.

Stablecoins Outranking Countries in US Debt Holding

Interestingly, stablecoins are now holding enough U.S. debt to rival some countries. The peg is the value the stablecoin is tying itself to, such as the US dollar. If a stablecoin is pegged to USD, that means that one unit of the stablecoin will equal one US dollar. The collateral currency is what s backing up the stablecoin; it s the stored value that helps the stablecoin maintain its peg. For example, a stablecoin couldThis highlights their growing importance in the global financial system.Stablecoins also provide a way to access U.S. dollars without needing a traditional U.S. bank account, opening new possibilities for global finance.

Benefits and Risks of Algorithmic Stablecoins

Algorithmic stablecoins offer several potential benefits:

Decentralization: They don't rely on a central authority to maintain their peg, offering greater decentralization.
Transparency: The rules governing the stablecoin are encoded in smart contracts, making them transparent and auditable.
Efficiency: They can facilitate faster and cheaper transactions compared to traditional payment systems.

However, they also come with significant risks:

Depeg Risk: The risk of losing their peg to the target currency is still present, especially during periods of market stress.
Complexity: The underlying algorithms can be complex and difficult for users to understand.
Regulatory Uncertainty: The regulatory landscape for stablecoins is still evolving, and there is a risk that new regulations could negatively impact algorithmic stablecoins.

The Future of Algorithmic Stablecoins

The future of algorithmic stablecoins remains uncertain, but the innovations and improvements being developed are promising.As projects learn from past mistakes and implement more robust mechanisms, algorithmic stablecoins could potentially play a significant role in the future of finance.The success of algorithmic stablecoins will depend on their ability to maintain their peg consistently, build trust among users, and navigate the evolving regulatory landscape.

Key Considerations for Investors

If you are considering investing in algorithmic stablecoins, it's essential to do your research and understand the risks involved.Consider these factors:

Collateral: What is the stablecoin backed by? Stablecoins now outrank countries in terms of buying and holding US debt. Stablecoins are also a new way to access the US dollar without US banking - that seems hands-off, but at the same timeIs the collateral diversified and transparently managed?
Algorithm: How does the algorithm work? The stablecoin s price aims to maintain a 1:1 ratio with the dollar, thanks to its dollar-denominated assets held in reserves. Unlike other crypto assets, Tether offers a level of price stability, making it a go-to for traders and investors alike. USD Coin (USDC) USD Coin, commonly known as USDC, is another stablecoin pegged to the U.S. dollar.Is it robust and responsive to market conditions?
Risk Management: What risk management mechanisms are in place? Think of it like a piggy bank for every stablecoin in circulation, there s an equivalent amount of real-world money sitting in reserve. This collateral system ensures the stablecoin s price stays close to its peg. Algorithmic Stablecoins: These innovative coins rely on computer programs and smart contracts to maintain their peg. InsteadHas the stablecoin been stress-tested?
Governance: Is there a decentralized governance system? Rebase algorithmic stablecoins use a method where the supply of the stablecoin is adjusted to maintain its peg to the US dollar. If the price of the stablecoin rises above $1, new coins are minted, and if the price drops below $1, coins are burned. Seigniorage algorithmic stablecoins use a multi-coin system to stabilize the stablecoin price.Who is involved in the decision-making process?
Team and Community: Who is behind the project?Is there an active and engaged community?

Conclusion

The quest for a truly stable and decentralized digital currency continues. Algorithmic stablecoins represent an ambitious attempt to achieve this goal, and while the path has been fraught with challenges, the sector is demonstrating remarkable resilience and innovation. One way this is achieved is through an algorithmic approach that automatically adjusts the coin's supply in response to changes in demand. If the price of the stablecoin rises above the peg, the algorithm increases supply to lower the price. Conversely, if the price falls below the peg, the algorithm decreases supply, pushing the price up.By learning from the failures of the past, embracing new strategies, and prioritizing transparency and risk management, algorithmic stablecoins may yet find a viable path to long-term stability and adoption. See full list on blog.kalinoff.comWhile the journey is ongoing, it remains a fascinating and important area of development in the cryptocurrency space.Remember, navigating the world of algorithmic stablecoins requires careful consideration and understanding of the inherent risks and potential rewards.As always, do your own research (DYOR) before investing in any cryptocurrency.