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A new finite-state vector quantization (FSVQ) algorithm is developed based on state space optimization and the derailment prevention requirement. The proposed derailment-free FSVQ (DF-FSVQ) achieves good performance through (i) state space reduction, which allows a practical implementation of high-order FSVQ, and (ii) derailment free state transitions. Experimental results show that our approach outperforms other known FSVQ schemes in terms of performance, system complexity, and processing speed, especially at low bit rate image coding.