To understand the major flaws of algorithmic stablecoins, it is important first to have a synopsis of what they are. Algorithmic stablecoins are cryptocurrencies designed to maintain a stable value by using an algorithm to adjust the supply of the cryptocurrency in circulation. Most algorithmic stablecoins work by adjusting the supply of the cryptocurrency based on demand to maintain a stable price.

However, algorithmic stablecoins suffer from several fundamental flaws that make them less reliable than traditional fiat-based stablecoins. These flaws include the following:

One of the primary concerns with algorithmic stablecoins is the absence of collateral, which means that there is no guarantee that the stablecoin can be redeemed for a fixed value. This lack of collateral can make investors reluctant to hold and use algorithmic stablecoins, and it can be difficult to evaluate their stability and assess investment risks.

Algorithmic stablecoins rely on market forces to maintain their stability, making them vulnerable to manipulation by large traders. A large trader’s decision to sell a significant amount of the stablecoin can trigger a chain reaction that leads to the stablecoin losing its stability. This makes algorithmic stablecoins more volatile than traditional fiat-based stablecoins that are typically backed by a reserve of fiat currency.

The algorithms used to maintain the stability of algorithmic stablecoins are often complex, making it difficult for investors to evaluate associated risks. Additionally, the algorithms’ constant adjustment of the stablecoin’s supply based on market demand can make it challenging to predict its behaviour over time.

Algorithmic stablecoins are often not subject to the same regulatory oversight as traditional fiat-based stablecoins. This lack of regulatory scrutiny makes it difficult for investors to assess investment risks. Additionally, because algorithmic stablecoins are decentralized and operate on a blockchain, regulators may find it challenging to monitor and regulate them effectively.

Algorithmic stablecoins are still relatively new and have not yet been widely adopted. Their association with many failures, such as UST and Basis Cash, has given them a negative reputation. This limits their usefulness as a stable store of value and makes them less suitable for everyday transactions. Also, as they are less well-known than traditional fiat-based stablecoins, investors may have difficulty finding exchanges and other platforms that support them.

Until a consistent, successful example of an algorithmic stablecoin that can scale to a broad user base emerges, these fundamental flaws will continue to be points of failure. As a result, many people will prefer other forms of stablecoins.

You can find out more about Poundtoken’s own reserves for the GBPT stablecoin here. For more information, visit our complete guide to stablecoins.