Crypto-backed stablecoins mirror their fiat-backed counterparts, with the main difference being that cryptocurrency is used as collateral. But since cryptocurrency is digital, smart contracts handle the issuance of units.
Crypto-backed stablecoins are trust-minimized, but it should be noted that monetary policy is determined by voters as part of their governance systems. This means that you’re not trusting a single issuer, but you’re trusting that all the network participants will always act in the users’ best interests.
To acquire this kind of stablecoin, users lock their cryptocurrency into a contract, which issues the token. Later, to get their collateral back, they pay stablecoins back into the same contract (along with any interest).
The specific mechanisms that enforce the peg vary based on the designs of each system. Suffice it to say, a mix of game theory and on-chain algorithms incentivize participants to keep the price stable.
Algorithmic stablecoins aren’t backed by fiat or cryptocurrency. Instead, their peg is achieved entirely by algorithms and smart contracts that manage the supply of the tokens issued. Functionally, their monetary policy closely mirrors that used by central banks to manage national currencies.
Essentially, an algorithmic stablecoin system will reduce the token supply if the price falls below the price of the fiat currency it tracks. If the price surpasses the value of the fiat currency, new tokens enter into circulation to reduce the value of the stablecoin.
You might hear this category of tokens referred to as non-collateralized stablecoins. This is technically incorrect, as they are collateralized – albeit not in the same way as the previous two entries. In the case of a black swan event, algorithmic stablecoins may have some kind of pool of collateral to handle exceptionally volatile market moves.