What Is an Algorithmic Stablecoin? Why They Depeg

An algorithmic stablecoin is a stablecoin that tries to hold a fixed price, usually 1 USD, mainly through code-driven supply changes and arbitrage incentives rather than through full backing by cash or overcollateralised crypto. When confidence holds, the mechanism works; when it breaks, these coins have a history of depegging fast and not coming back.

Algorithmic stablecoin definition

Stablecoins differ mainly in what stands behind each coin. Fiat-backed stablecoins hold cash and short-term government debt. Overcollateralised stablecoins hold more crypto than the coins they issue, for example 150 USD of collateral per 100 USD of stablecoins. Algorithmic stablecoins hold little or no independent collateral and rely on rules that expand or contract supply. See stablecoins explained for the full family tree.

The most common design pairs the stablecoin with a second, volatile token. The protocol always lets you swap 1 stablecoin for 1 USD worth of the volatile token, and the reverse, and arbitrageurs are expected to keep the price at 1 USD.

A "depeg" is when a stablecoin trades meaningfully away from its target price. Every type of stablecoin can depeg briefly; algorithmic designs are prone to depegs that feed on themselves.

How an algorithmic stablecoin works

1. Above the peg. If the stablecoin trades at 1.02 USD, arbitrageurs burn 1 USD of the volatile token to mint 1 stablecoin and sell it for 1.02. Supply rises and the price falls back.
2. Below the peg. If it trades at 0.98, arbitrageurs buy it cheaply and burn it to mint 1 USD of the volatile token. Supply shrinks and the price recovers.
3. The weak point. Step 2 only works if the volatile token keeps its value. If many holders redeem at once, the protocol mints huge amounts of the volatile token, its price collapses, each redemption needs even more of it, and the loop accelerates. This is the "death spiral".

Some designs add partial collateral, reserves or delta-hedged positions to soften this. Ethena's USDe, for example, is described as a synthetic dollar backed by hedged positions rather than a pure algorithmic coin; our USDe explainer covers how its risks differ.

Algorithmic stablecoin example

Say a hypothetical stablecoin has 1,000,000,000 coins outstanding, paired with a governance token worth 10 USD with 100,000,000 tokens in circulation (a 1 billion USD market cap). Holders redeem 300,000,000 stablecoins in a panic. The protocol must mint 300 million USD of the governance token, or 30,000,000 tokens at 10 USD.

But the sellers dump those tokens, and the price drops to 4 USD. The next 300 million USD of redemptions now needs 75,000,000 tokens. Supply balloons, the price falls further, and the stablecoin slides to 0.60, then 0.20.

This is close to what happened to TerraUSD (UST) in May 2022: within about a week UST fell to around 10 cents, LUNA fell from an all-time high of about 119 USD to virtually zero, and close to 45 billion USD of market capitalisation was wiped out (Wikipedia, checked October 2026).

Why algorithmic stablecoins matter

• Reflexivity. The backing is the confidence of the market. When confidence falls, backing falls with it.
• High yields as bait. Unsustainable deposit rates can attract capital that leaves all at once. Ask where the yield comes from.
• Contagion. Lending markets, pools and other stablecoins that hold the coin can be dragged down too.
• Behaviour. Depegs are bank runs. Our psychology of a depeg piece explains why people sell together.
• Check the label. Many coins marketed as "stable" mix models. Read what actually backs each coin and how redemption works.

Related terms

• Price oracle — the feed contracts use to read prices, critical during depegs.
• Tokenomics — how a token's supply and incentives are designed.
• Real yield — yield paid from real revenue rather than new tokens.
• Liquidity pool — a pool of tokens that traders swap against, where depegs show up first.
• Rug pull — when a project's creators drain funds and disappear.

Learn more on the JewelSwap blog

• Stablecoin depegs explained — the history of major depegs and what caused each one.
• Stablecoins explained — fiat-backed, crypto-backed and algorithmic designs compared.
• What is USDe (Ethena)? — how a hedged synthetic dollar works and where its risks sit.
• The psychology of a depeg — why holders panic together and how runs unfold.

Frequently asked questions

What does depeg mean?

A depeg is when a stablecoin trades meaningfully away from its target price, usually below 1 USD. Short depegs can recover; algorithmic stablecoins have a history of depegs that turn into collapses.

Algorithmic stablecoin vs overcollateralised stablecoin: what is the difference?

An overcollateralised stablecoin holds more crypto collateral than the coins it issues and can liquidate it to defend the peg. An algorithmic stablecoin relies mainly on minting and burning a paired token, so its backing depends on that token's market value.

Are algorithmic stablecoins safe?

They carry more risk than fully backed stablecoins because their backing can vanish in a run. Several, including TerraUSD in 2022, have lost almost all their value. Treat high yields on them with caution.

JewelSwap Crypto Glossary · educational, not financial advice. Updated 2 October 2026. Browse the full glossary.