Algorithmic stablecoins and their role in the digital asset market

Stablecoins have become an analogue of fiat money for the cryptocurrency sector, allowing investors to protect themselves from the high volatility of digital assets. Currencies and various assets, such as government bonds, backed the first stablecoins.

It was the backing by tangible assets that formed the basis of the peg mechanism for classic stablecoins such as Tether (USDT) and USDC (USDC). However, developers later came up with a different concept, in which a stablecoin's peg to the price of an underlying asset would be maintained not by collateral, but by a software algorithm.

What are algorithmic stablecoins?

Algorithmic stablecoins are a type of stablecoin whose value relative to a pegged currency or asset is maintained not through asset reserves but through mathematical calculations implemented by smart contracts.

The key objective of algorithmic stablecoins, as with any others, is to peg the token's value to a base currency whose exchange rate the stablecoin tracks. For example, if an algorithmic stablecoin is pegged to the US dollar, the algorithm must keep the token's price close to $1. If the cost of an algorithmic stablecoin deviates significantly from the price of the underlying asset (by 1% or more), this event is referred to as a loss of the peg to the currency or another asset, or a "depeg."

A special algorithm regulates the supply of the algorithmic stablecoin on the market in response to investor demand. This works as follows:

1. If demand increases, the price of the algorithmic stablecoin rises and moves above $1. In this case, the algorithm increases supply until the price stabilizes at around $1;
2. When demand decreases, the price of the stablecoin falls below $1. In this case, the algorithm reduces supply by burning (removing from circulation) part of the tokens until the value returns to $1.

Due to several collapse cases, algorithmic stablecoins are not very popular among investors, who prefer more resilient classic stablecoins. According to CoinMarketCap data as of January 2026, the market capitalization of algorithmic stablecoins is about $1 billion — more than 190 times smaller than the of USDT alone. At the same time, algorithmic stablecoins account for only 0.3% of the total stablecoin market capitalization.

Types and examples of algorithmic stablecoins

As with classic stablecoins, algorithmic stablecoins are also divided into several categories depending on how they operate and on the mechanism used to maintain the peg to the underlying asset or currency.

1. Pure algorithmic stablecoins

The peg mechanism in pure algorithmic stablecoins is based on the redistribution of supply and demand. This mechanism is also known as the rebase model*.

* Rebase — an algorithmic mechanism for regulating token supply in which the total number of coins in circulation automatically increases or decreases depending on the deviation of the market price from the target value, without changing each holder's ownership share.

Perhaps the most well-known representative of this category of algorithmic stablecoins was the infamous TerraUSD (UST), whose price collapsed amid massive sell-offs that triggered a "death spiral." UST tokens were issued by burning the native token of the Terra platform, LUNA.

The UST token highlighted the significant risks of purely algorithmic tokens that lack collateral to protect against depegging. The value of UST collapsed by more than 99% to $0.0075 with a market capitalization of $39 million.

However, there are also successful examples of purely algorithmic stablecoins, such as Ampleforth (AMPL), which is based exclusively on the rebase model. Although AMPL's market capitalization is only $35 million, the stablecoin's value remains close to $1.

2. Algorithmic stablecoins with a hybrid model

In addition to algorithms, hybrid algorithmic stablecoins use additional assets as collateral to maintain their peg. The form of this collateral may vary.

For example, in the MakerDAO protocol, collateral in various tokens such as ETH and USDT is used to issue Dai (DAI) tokens — similar to lending.

Other examples of algorithmic stablecoins with a hybrid model include USDD and Frax USD (FRXUSD). USDD, issued within the Tron ecosystem, uses an overcollateralization mechanism combined with a dual-token model. As of January 2026, USDD is one of the largest algorithmic stablecoins by market capitalization, with a market cap of $861 million.

3. Algorithmic stablecoins based on delta-neutral hedging

Some stablecoins use more complex mechanisms to ensure price stability, such as delta-neutral strategies in futures markets. An example of such a stablecoin is Ethena USDe (USDe), which many experts consider the next evolutionary step of algorithmic stablecoins. CoinMarketCap, for instance, even calculates its capitalization separately from other algorithmic stablecoins. This is even though USDe also uses a hybrid model to ensure token stability.

USDe is the largest algorithmic stablecoin, with a market capitalization exceeding $6.3 billion, and ranks among the top three tokens in the stablecoin segment, surpassing even DAI and PayPal USD (PYUSD).

Advantages of algorithmic stablecoins

The key advantage of algorithmic stablecoins is decentralization, since such tokens can be issued by any user using special functions embedded in smart contracts. There is no need to contact a central authority (issuer) or go through a complex bureaucratic procedure.

In addition, issuers of classic stablecoins may not provide issuance services in certain regions. When using algorithmic stablecoins, so-called counterparty risks are absent — users do not need to trust third parties controlling the smart contract and instead rely solely on the algorithm.

Algorithmic stablecoins can also be scaled quickly, unlike classic stablecoins, which are constrained by regulatory rules and the need to coordinate reserves.

Risks of algorithmic stablecoins

The main risk for algorithmic stablecoins is depegging. Due to the complexity of the algorithms, developers may fail to account for certain factors that could lead to a token's collapse in the future. Uncollateralized algorithmic stablecoins are especially vulnerable to this risk.

In addition, for many investors, the absence of reserves may not inspire confidence, as there are no guarantees of compensation if a stablecoin loses its peg to the underlying asset or currency.