This paper investigates the challenges in mitigating several power quality (PQ) problems by a single distribution static compensator (DSTATCOM), and proposes a reduced rating voltage controlled hybrid DSTATCOM with multi-functional features. This scheme connects a suitably designed external inductor, as a part of the load, between the source and load points. This inductor improves the voltage regulation bandwidth of DSTATCOM and reduces the current requirement for voltage sag mitigation. Along with this, a multi-functional algorithm is proposed to generate dynamic reference load voltage. This algorithm indirectly controls the source currents during normal operation to mitigate current related PQ problems, whereas maintains a constant voltage at the load terminal during voltage disturbances. Simulation results are presented to validate the capability of single DSTATCOM to mitigate several PQ problems. © 2013 IEEE.