What Is the Difference between an Algorithmic and a Fiat-Backed Stablecoin?
A fiat-backed stablecoin maintains its peg by holding equivalent reserves, such as US Dollars or short-term treasuries, for every coin issued. An algorithmic stablecoin, however, attempts to maintain its price peg through automated smart contracts that manage the supply.
It often uses a secondary, volatile cryptocurrency as collateral or a stabilization mechanism. Fiat-backed coins aim for 1:1 redeemability, while algorithmic coins rely on market incentives and code.
The former faces reserve quality risk, the latter faces design and execution risk.
Dictionary
Algorithmic Stablecoin
Anchor ⎊ A collateralization scheme or algorithmic feedback loop designed to enforce a stable relationship between the asset's market price and a fiat currency or basket of assets.
Fiat-Backed
Collateral ⎊ The concept of fiat-backed cryptocurrency or derivatives fundamentally rests on the provision of collateral, typically held by a custodian or escrow agent, to represent the underlying value.