While most stablecoins are backed by reserves, algorithmic stablecoins use math and incentive mechanisms to secure their fiat peg. Decentralized Finance (DeFi) is a complex and rapidly evolving industry, full of experimentation and innovation, and built on the philosophical and ideological foundations of a more efficient, censorship-resistant, and open decentralized financial system. Algorithmic stablecoins are an example of all these traits; it is part monetary economics, part financial markets, part mathematics, and part technology. Being at the intersection of money and blockchain technology, they are newer and more complex, and create an abundance of problems, leaving many questions unanswered about how the future of DeFi will develop. In this article, we will look at what algorithmic stablecoins are, how they work, and how they differ from traditional stablecoins. What are algorithmic stablecoins? Stablecoins are cryptocurrencies that determine their value in relation to something else; it is usually a fiat currency such as USD. Since stablecoins are pegged to a known and stable price, investors or traders often use them to stay in the cryptocurrency markets and at the same time be able to protect themselves from price volatility in these markets.

Most stablecoins seek to achieve their peg using some of the collateral mechanisms. Circulating stablecoins are backed by assets whose value must guarantee the value of the stablecoin. Most major stablecoins such as USDC and Tether (USDT) are backed by off-chain collateral like USD, which is held in a centralized entity such as a bank. However, stablecoins can also be secured on-chain (blockchain transaction) using decentralized mechanisms, as is the case with DAI. .