The post-COVID-19 period has introduced the difficulty of inflation to the forefront, resulting in growing curiosity throughout the Web3 house for creating flatcoins, a detailed “cousin” of stablecoins designed to mitigate inflation danger.
Many current flatcoins, like Terra’s TerraUSD (UST) stablecoin, are algorithmically backed and subsequently function a stark reminder of the dangers related to algorithmic backing, as demonstrated by the collapse of LUNA and UST. So, whereas the thought behind flatcoins could appear interesting, they increase vital reservations conceptually and when it comes to design. Finally, the success of flatcoins will depend upon whether or not builders can ship on their promise.
So far, flatcoin white papers — together with the one supplied by Coinbase — don’t seem to ship on their envisioned promise, at the very least of their present state. Specifically, the token economics designs of some tasks are prone to pose an excellent larger danger than up to date stablecoin designs.
Issues on the conceptual degree
Analyzing the potential use instances of flatcoins is certainly essential. Whereas typically introduced as an asset that may assist customers protect their buying energy amid inflation and financial uncertainty, this concept might be deceptive.
Stablecoins are digitized variations of fiat currencies, and their worth as a medium of alternate and unit of account is similar as that of fiat currencies. In distinction, flatcoins are indexes of the shopping for energy of a fiat foreign money obtained by way of oracles that accumulate information on financial indicators such because the Client Worth Index (CPI).
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Because of this, the unit worth of flatcoins will diverge from the fiat foreign money they monitor over time so long as inflation just isn’t zero. Due to this fact, the existence of flatcoins depends upon the idea that fiat currencies or their digitized varieties are the mediums of alternate and models of account.
In different phrases, there won’t be a state of affairs the place flatcoins are higher than stablecoins or fiat currencies as mediums of alternate and models of account as a result of the existence of flatcoins hinges on the prevalence of fiat currencies and stablecoins at these roles.
Inflation-pegged belongings exist already
Flatcoins are monetary devices that expose buyers to inflation charges, making them a spinoff of inflation. Asset lessons that expose buyers to inflation danger have been round for a very long time.
As an example, Treasury Inflation-Protected Securities (TIPS) have been used since 1997 to handle inflation dangers tied to fixed-rate bonds. Retail buyers can simply entry TIPS and achieve publicity to inflation by way of exchange-traded funds (ETFs) of their brokerage accounts.
The supply of those established inflation-linked asset lessons by way of ETFs signifies that institutional and retail buyers can simply handle their publicity to inflation. The potential worth proposition of flatcoins as an funding automobile for inflation hedging could also be restricted.
Regardless of some criticisms of flatcoins, they do have the potential to deliver worth to the economic system. The true innovation of flatcoins lies of their integration of conventional monetary devices onto the blockchain. Flatcoins are a digitalization of an current asset class, much like how stablecoins digitize fiat currencies. This innovation could permit for extra environment friendly monetary transactions and creates competitors with conventional monetary intermediaries reminiscent of TIPS ETFs, probably resulting in higher effectivity and decrease prices in monetary markets. Nevertheless, it’s important to acknowledge that the existence of flatcoins just isn’t the salvation of the macroeconomic challenges we face at this time.
Design-level issues
Earlier discussions revolved across the potential makes use of and improvements of flatcoins. Nevertheless, it’s important to notice that the present growth of an inflation-pegged stablecoin remains to be in its infancy and faces vital challenges.
A couple of tasks are at the moment in progress which might be growing CPI-indexed flatcoins, however these tasks depend on mechanisms much like stablecoins. Some current flatcoin designs, reminiscent of Frax Worth Index Share (FPIS) and Reflexer’s Rai Reflex Index (RAI), algorithmically regulate the provision of the flatcoin to take care of the peg to a selected purchasing-power-related index, much like how algorithmic stablecoins preserve their pegs to fiat currencies.
Nevertheless, algorithmic stablecoins have confirmed to be a dangerous design class, as excessive market circumstances could cause a downward spiral much like a financial institution run, as seen within the case of Terra’s collapse.
For instance, Frax Finance’s white paper on the pegging mechanism of its Frax Worth Index (FPI) states:
“Throughout instances that AMO yield is below the CPI fee, a TWAMM AMO will promote FPIS tokens for FRAX stablecoins to maintain the CR at 100% always.”
To simplify, it states that the protocol will promote index tokens for Frax Finance’s stablecoin if the CPI index’s return falls under its precise worth. Nevertheless, this design poses a vulnerability frequent in algorithmic stablecoins. If the protocol runs out of reserve Frax Worth Index Share (FPIS) tokens, a run much like Terra’s will probably occur.
Moreover, as inflation not often goes unfavourable, fixed gross sales of FPIS tokens might be essential to take care of the 100% collateral ratio, making this design much more vulnerable to runs than different algorithmic stablecoin designs.
The tradeoff of counting on one thing apart from algorithmic adjustment is the reliance on centralized authorities. Stablecoin tasks that use fiat cash as collateral depend on belief within the challenge to take care of U.S. greenback escrow. In distinction, these relying on overcollateralized crypto belongings are topic to market dangers. Sadly, flatcoin tasks nonetheless want to offer an answer to this downside.
One other essential barrier to growing an efficient buying energy index with flatcoins lies within the accuracy of the information offered by oracle protocols. Counting on publicly out there CPI information printed by the Bureau of Labor Statistics alone would restrict the true potential of flatcoins. Initiatives reminiscent of Chainlink and (my very own) IoTeX’s W3bstream have the potential to offer real-time information that might make correct and well timed CPI information doable.
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The success of flatcoins will depend upon the continued innovation of oracle groups. A decentralized flatcoin index may considerably enhance current funding devices for hedging inflation danger if creators can obtain real-time CPI information.
Dangers and uncertainties
The widespread adoption of flatcoins and related cryptocurrencies depends upon their means to beat the inherent challenges and dangers of stablecoin designs.
As flatcoins and different inflation-indexed cryptocurrencies emerge, evaluating their influence on the broader monetary ecosystem is essential. Do they supply a extra secure and decentralized various to conventional currencies, or are they only one other funding automobile?
Buyers, customers and regulators should fastidiously study new developments within the digital asset house. Understanding these cryptocurrencies’ true nature and potential is significant to figuring out whether or not they’ll turn into dominant within the monetary panorama or stay an intriguing however area of interest funding possibility.
Flatcoins’ emergence highlights the continuing pursuit of stability and decentralization within the digital asset enviornment. Though this new monetary instrument introduces an progressive method, it carries extra dangers and uncertainties. Buyers, customers and regulators can higher navigate the way forward for inflation-indexed cryptocurrencies by sustaining a essential eye on these developments.
Peter Han holds a Ph.D. in finance from the College of Illinois Urbana-Champaign, concentrating in monetary intermediation and fintech, along with a grasp’s diploma in monetary engineering. He holds a BA in English and BS in arithmetic from China’s Tianjin College. He labored for PwC in Beijing earlier than becoming a member of IoTeX, the place his work focuses on tokenomics-related analysis aimed toward enhancing IoTeX’s tokenomics design.
This text is for normal info functions and isn’t supposed to be and shouldn’t be taken as authorized or funding recommendation. The views, ideas and opinions expressed listed below are the writer’s alone and don’t essentially replicate or characterize the views and opinions of Cointelegraph.