The stunning meltdown of UST stablecoin and LUNA, its sister token, has many wondering about algorithmic stablecoins and how they are supposed to work. eking0x explains the crypto concept and what's happening now:
Over the past year, however, a new form of stablecoin has emerged that differs in its collateralization: algorithmic stablecoins, such as terraUSD , magic internet money , frax and neutrino usd .
In the case of the Terra blockchain, which runs the largest algorithmic stablecoin platform, the algorithmic tango is performed by UST, a stablecoin, and terra , Terra’s native cryptocurrency that backs the stablecoin. For the remainder of this article, we will use “LUNA” to refer to terra to avoid any confusion.Algorithmic stablecoins are typically undercollateralized – they don’t have independent assets in reserves to back the value of their stablecoins.
Cryptocurrencies – similar to all assets in the market, such as houses or stocks – move up and down in price depending on the market demand and the supply of the asset. This also includes stablecoins because they’re essentially cryptocurrencies freely traded on the market. The algorithm’s promise is to keep this in check, as we explore in the context of UST in the next section, before delving deeper into how that can go terribly wrong.TerraUSD maintains – or is supposed to maintain – its 1:1 parity with the U.S. dollar via an algorithmic relationship with Terra’s native cryptocurrency, LUNA. Behind the relationship is anWhen the UST supply is too small and demand for it is too high, the price of UST goes above $1.
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