TerraUSD meltdown, part 2: What is an algorithmic stablecoin?

Welcome to the cryptohunt jam where we spend one minute a day to explain crypto. In plain english.

Remember the last episode about a peg, the rubber band that keeps a stablecoin stable? Welcome to part two of our one-week special on the TerraUSD collapse. Today: How does an algorithmic stablecoin actually work?

Let’s remember the rubber band analogy. If the value of a stable coin moves too high, the rubber band has to snap back, and the same happens in the opposite direction.

There are two types of stable coins: Collateralized and algorithmic. Collateralized coins are easy to understand: There is real money in a central reserve backing them, and whenever someone wants to exchange a stablecoin back, the real money gets taken from the reserve.

Algorithmic stablecoins are different. They use computer code to balance their price automatically. The most simple ones just create more of their own coins - which decreases the price - or invalidate existing ones - which increases the price.

But since computer code can do much more complicated things, people have also built far crazier mechanisms into stable coins. The problem is that these work in 99.9% of the real-world use cases, but in those rare moments of extreme tension, the rubber band tears and the system collapses.

And that’s exactly what happened with TerraUSD. The algorithm tripped, fell on its nose, and kicked off a snowball that turned into an avalanche. So, in the next episode, let’s look behind the curtains of how TerraUSD was working to understand what went wrong.

Disclaimer: This podcast references our opinion and is for information purposes only. It is not intended to be investment advice. Do your own research and seek a duly licensed professional for investment advice.