The post-COVID-19 period has introduced the problem 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 threat.
Many current flatcoins, like Terra’s TerraUSD (UST) stablecoin, are algorithmically backed and due to this fact 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 elevate important reservations conceptually and when it comes to design. Ultimately, the success of flatcoins will rely upon whether or not builders can ship on their promise.
To date, flatcoin white papers — together with the one provided by Coinbase — don’t seem to ship on their envisioned promise, at the least of their present state. In specific, the token economics designs of some initiatives are more likely to pose a fair increased threat than up to date stablecoin designs.
Problems on the conceptual degree
Examining the potential use circumstances of flatcoins is certainly essential. While typically offered 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 identical as that of fiat currencies. In distinction, flatcoins are indexes of the shopping for energy of a fiat forex obtained by oracles that accumulate knowledge on financial indicators such because the Consumer Price Index (CPI).
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As a consequence, the unit worth of flatcoins will diverge from the fiat forex they observe over time so long as inflation just isn’t zero. Therefore, the existence of flatcoins will depend on the idea that fiat currencies or their digitized kinds are the mediums of alternate and items of account.
In different phrases, there is not going to be a scenario the place flatcoins are higher than stablecoins or fiat currencies as mediums of alternate and items of account as a result of the existence of flatcoins hinges on the prevalence of fiat currencies and stablecoins at these roles.
Inflation-pegged property exist already
Flatcoins are monetary devices that expose buyers to inflation charges, making them a by-product of inflation. Asset lessons that expose buyers to inflation threat have been round for a very long time.
For occasion, 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 exchange-traded funds (ETFs) of their brokerage accounts.
The availability of those established inflation-linked asset lessons by ETFs implies that institutional and retail buyers can simply handle their publicity to inflation. The potential worth proposition of flatcoins as an funding car for inflation hedging could also be restricted.
Despite some criticisms of flatcoins, they do have the potential to convey 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, just like how stablecoins digitize fiat currencies. This innovation could enable for extra environment friendly monetary transactions and creates competitors with conventional monetary intermediaries akin to TIPS ETFs, probably resulting in better effectivity and decrease prices in monetary markets. However, it’s important to acknowledge that the existence of flatcoins just isn’t the salvation of the macroeconomic challenges we face at present.
Design-level issues
Previous discussions revolved across the potential makes use of and improvements of flatcoins. However, it’s important to notice that the present growth of an inflation-pegged stablecoin continues to be in its infancy and faces important challenges.
A number of initiatives are at the moment in progress which are creating CPI-indexed flatcoins, however these initiatives depend on mechanisms just like stablecoins. Some current flatcoin designs, akin to Frax Price 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, just like how algorithmic stablecoins maintain their pegs to fiat currencies.
However, algorithmic stablecoins have confirmed to be a dangerous design class, as excessive market situations may cause a downward spiral just 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 Price Index (FPI) states:
“During times that AMO yield is under the CPI rate, a TWAMM AMO will sell FPIS tokens for FRAX stablecoins to keep the CR at 100% at all times.”
To simplify, it states that the protocol will promote index tokens for Frax Finance’s stablecoin if the CPI index’s return falls beneath its precise worth. However, this design poses a vulnerability widespread in algorithmic stablecoins. If the protocol runs out of reserve Frax Price Index Share (FPIS) tokens, a run just like Terra’s will probably occur.
Additionally, as inflation not often goes destructive, fixed gross sales of FPIS tokens will probably be mandatory to take care of the 100% collateral ratio, making this design much more inclined 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 initiatives that use fiat cash as collateral depend on belief within the mission to take care of U.S. greenback escrow. In distinction, these relying on overcollateralized crypto property are topic to market dangers. Unfortunately, flatcoin initiatives nonetheless want to supply an answer to this drawback.
Another essential barrier to creating an efficient buying energy index with flatcoins lies within the accuracy of the info offered by oracle protocols. Relying on publicly out there CPI knowledge revealed by the Bureau of Labor Statistics alone would restrict the true potential of flatcoins. Projects akin to Chainlink and (my very own) IoTeX’s W3bstream have the potential to supply real-time knowledge that would make correct and well timed CPI knowledge potential.
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The success of flatcoins will rely upon the continued innovation of oracle groups. A decentralized flatcoin index may considerably enhance current funding devices for hedging inflation threat if creators can obtain real-time CPI knowledge.
Risks and uncertainties
The widespread adoption of flatcoins and comparable cryptocurrencies will depend on their capability to beat the inherent challenges and dangers of stablecoin designs.
As flatcoins and different inflation-indexed cryptocurrencies emerge, evaluating their impression on the broader monetary ecosystem is essential. Do they supply a extra secure and decentralized different to conventional currencies, or are they simply one other funding car?
Investors, customers and regulators should fastidiously look at new developments within the digital asset house. Understanding these cryptocurrencies’ true nature and potential is significant to figuring out whether or not they’ll grow to be dominant within the monetary panorama or stay an intriguing however area of interest funding choice.
Flatcoins’ emergence highlights the continuing pursuit of stability and decentralization within the digital asset enviornment. Although this new monetary instrument introduces an revolutionary strategy, it carries extra dangers and uncertainties. Investors, 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 University 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 University. He labored for PwC in Beijing earlier than becoming a member of IoTeX, the place his work focuses on tokenomics-related analysis geared toward enhancing IoTeX’s tokenomics design.
This article is for common data functions and isn’t meant to be and shouldn’t be taken as authorized or funding recommendation. The views, ideas and opinions expressed listed here are the writer’s alone and don’t essentially replicate or signify the views and opinions of Cointelegraph.
