An algorithmic stablecoin uses code and incentive mechanisms — rather than real asset reserves — to maintain its price peg. When price rises above the peg, the protocol mints new tokens to dilute supply; when price falls below, it buys back or burns tokens to contract supply, theoretically returning the price to target. The core assumption: 'as long as market participants believe the mechanism works, the system sustains itself.' But this assumption often fails under extreme stress, triggering death-spiral collapses. The 2022 UST collapse is the most destructive failure case to date, and has left markets and regulators highly skeptical about the viability of pure algorithmic stablecoins.

Death spiral is the self-reinforcing collapse loop that algorithmic stablecoins can enter after de-pegging: stablecoin price falls → holders panic-redeem → paired token gets massively minted to maintain the peg → paired token collapses from inflation → stablecoin loses further confidence → more selling… until the entire system reaches zero. The core problem is that the mechanism meant to maintain the peg actually accelerates the collapse under stress. The 2022 Terra/UST collapse is the most destructive death spiral case to date, with approximately $40 billion in market cap evaporating within a week.