Types of algo-stables

Rebasing algo-stables

The overall supply of rebase algo-stables is not fixed, and is adaptively adjusted on a regular basis. The adjustment is made automatically by the rebase process, which gradually stabilizes the price of the asset towards a peg; for example, 1 USD.
The Ampleforth protocol has a feature called rebasing that changes the token supply. This means that the number of $AMPL tokens in your wallet will change every 24 hours based on the average token price over the specified time.‍

Seigniorage algo-stables

Seigniorage algo-stables have no reserves in smart contracts. This type of algo-stable is backed exclusively by algorithms. Seigniorage-style algo-stables rely on complex processes to adjust the circulating supply of their coins in response to supply and demand.‍

Over-collateralized algo-stables

This type of algo-stable needs a large amount of cryptocurrency, which is kept as a reserve to issue fewer assets. This large reserve serves as protection against price fluctuations. An example of an over-collateralized algo-stable is MakerDAO's $DAI, which is collateralized by the cryptocurrency ETH. $DAI requires a minimum of 150 % collateralization, meaning that if the price of the underlying cryptocurrency drops low enough, a liquidation process will begin. During the liquidation process, enough collateral is sold to cover the debt along with a liquidation penalty, leaving the remaining collateral available for withdrawal.‍

Fractional algo-stables

Fractional algo-stables are partially collateralized. They are backed by both asset collateralization and cryptographic algorithms. This protocol uses two different assets; namely, the stablecoin Frax ($FRAX) (to maintain a 1:1 peg to the US dollar) and the governance and utility token Frax Share ($FXS).

Advantages of algo-stables

• Algo-stables are the true embodiment of decentralization, because the code defines the exact rules of operation
• No regulatory authorities control your transactions
• Higher returns for interest-earning assets

Disadvantages of algo-stables

• The potential risks associated with algo-stables are that they may be weak in times of financial crisis, or in periods of extreme volatility
• De-peg risk. This is the worst-case scenario for any stablecoin, as it can destabilize algorithmic stablecoins and cause price fluctuations that could eventually kill the entire project

Are algo-stables safe?

The algo-stables market is unregulated, so investing carries the risk of devaluation and vulnerability to speculative attacks if there is insufficient collateralization. If the supply of algo-stables is linked to the value of the native blockchain token, the risk of devaluation increases even further. Therefore, before deciding to invest in algo-stables or any other digital asset, it is essential to conduct thorough analysis in order to understand the basics of how it works and the various technical signals, which could be very challenging for a newcomer.

Conclusion

Algo-stables provided the ideal prospect of decentralization without any regulatory bodies. With the fundamental benefits of algo-stables, you can have a truly scalable solution compared with other alternatives. Algo-stables rely on code that is both transparent and auditable, providing favorable prospects for building trust.

Obviously, even in the case of algo-stables, there are still gray areas that will need to be worked on diligently. The $UST - $LUNA incident has highlighted some potential areas of concern. Perhaps the current technology is not sophisticated enough. Algorithmic stablecoins rely on complex technical-financial engineering to maintain a stable value, and we will probably have to wait some time before someone comes up with the perfect system to make use of their functionality.

Personal Opinion

After previous experience with algo-stables, it is clear to me that many of them work perfectly until the moment at which they stop. In cases of major de-pegging, the problem is all over the place and few people manage to save the project. However, I am convinced that DeFi needs its truly functional algo-stables, and I will be watching the next developments in this sector very closely. If you plan to invest in algo-stables, always be prepared to accept a certain amount of risk and diversify your investments wisely. Your main task is to ensure that you are earning consistent profits for the minimum possible level of risk. Always DYOR!