How Does a ‘Death Spiral’ Relate to Under-Collateralization?
A 'death spiral' is a catastrophic feedback loop that can occur in under-collateralized or poorly designed algorithmic stablecoins. It starts when the stablecoin loses its peg and falls below $1.
The algorithm attempts to restore the peg by issuing a secondary, volatile asset (like a governance token) to absorb the stablecoin supply. If the stablecoin's price continues to drop, the value of the secondary asset collapses, creating a lack of confidence that leads to mass selling of both tokens, further driving down prices and leading to the system's failure and permanent under-collateralization.
