Algorithmic token is a form of cryptocurrency that uses an algorithmic mechanism to manage its price or supply. The price and issuance of an algorithmic token are regulated by a pre-defined algorithm written in the blockchain and implemented through a chain of smart contracts.
Difference between algorithmic and regular tokens
A regular token and an algorithmic token are two different types of cryptocurrencies.
- Regular or classic token, also known as a blockchain-based token, is a digital asset that operates on the blockchain of another cryptocurrency, such as Ethereum or DEL. These tokens rely on market conditions, issuer policies, or the blockchain itself, and therefore can have high volatility.
- An algorithmic token uses mathematical algorithms to automatically regulate its price and supply based on current market conditions. For example, it may increase the supply if the token price is too high or decrease it if the price is too low. The price of an algorithmic token is not determined by market conditions or the actions of third parties, such as central banks or exchanges. Examples of algorithmic tokens include Ampleforth (AMPL) and Elastic (XEL).
How algorithmic tokens work
Special programmatic algorithms are written when creating the token, which automatically adjust its price and circulating supply based on certain conditions.
If the token price rises, the algorithm triggers additional token issuance and brings them into the market.
If the price falls below a certain threshold, the algorithm withdraws the necessary amount of tokens from circulation and initiates their liquidation (burning).
This ensures higher stability of algorithmic tokens compared to regular tokens and provides additional income for holders of such tokens if the blockchain implements a corresponding system.
This feature of algorithmic tokens is used to create algorithmic stablecoins.