An algorithmic stablecoin is a price-stable cryptocurrency or digital asset that uses a second token to maintain its peg to a real-world asset, e.g., the US dollar. The price stability mechanism of an algorithmic stablecoin involves adjusting the circulating supply of the second token based on the demand for the stablecoin.
This differs from conventional stablecoins that are backed by collateral and can be redeemed on a 1:1 basis for the asset they represent, such as fiat currencies. Instead, an algorithmic stablecoin is typically undercollateralized and does not have independent reserves for redeeming the stablecoin for the asset.
It is backed by another crypto asset whose value and supply fluctuate to maintain the peg of the algorithmic stablecoin it supports. For instance, higher demand for such a stablecoin in the market could result in higher burning of the second token, which would drive its price up to maintain the peg.
On the other hand, a drop in demand for such a stablecoin could result in higher minting of the second token, increasing its circulating supply and weakening its price to adjust the price of the algorithmic stablecoin.