The post-COVID-19 period has introduced the problem of inflation to the forefront, resulting in rising curiosity throughout the Web3 area 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 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 seem interesting, they elevate important reservations conceptually and by way of 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, no less than of their present state. Specifically, the token economics designs of some tasks are more likely to pose a good greater threat than modern stablecoin designs.
Issues on the conceptual stage
Inspecting the potential use instances of flatcoins is certainly essential. Whereas usually introduced as an asset that may assist customers protect their buying energy amid inflation and financial uncertainty, this concept could possibly 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 acquire information on financial indicators such because the Client Worth Index (CPI).
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In consequence, the unit worth of flatcoins will diverge from the fiat forex they monitor over time so long as inflation just isn’t zero. Due to this fact, the existence of flatcoins is determined by the idea that fiat currencies or their digitized types are the mediums of alternate and items of account.
In different phrases, there won’t 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 belongings exist already
Flatcoins are monetary devices that expose traders to inflation charges, making them a by-product of inflation. Asset courses that expose traders to inflation threat have been round for a very long time.
For example, Treasury Inflation-Protected Securities (TIPS) have been used since 1997 to handle inflation dangers tied to fixed-rate bonds. Retail traders can simply entry TIPS and acquire publicity to inflation by exchange-traded funds (ETFs) of their brokerage accounts.
The supply of those established inflation-linked asset courses by ETFs implies that institutional and retail traders 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 financial 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 enable for extra environment friendly monetary transactions and creates competitors with conventional monetary intermediaries comparable to TIPS ETFs, probably resulting in larger 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 present.
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 important challenges.
Just a few tasks are at present in progress which are growing CPI-indexed flatcoins, however these tasks depend on mechanisms much like stablecoins. Some current flatcoin designs, comparable to Frax Worth Index Share (FPIS) and Reflexer’s Rai Reflex Index (RAI), algorithmically alter the availability of the flatcoin to keep up the peg to a particular purchasing-power-related index, much like how algorithmic stablecoins maintain their pegs to fiat currencies.
Nevertheless, algorithmic stablecoins have confirmed to be a dangerous design class, as excessive market circumstances may 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 underneath the CPI price, 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 detrimental, fixed gross sales of FPIS tokens can be obligatory to keep up the 100% collateral ratio, making this design much more vulnerable to runs than different algorithmic stablecoin designs.
The tradeoff of counting on one thing aside from algorithmic adjustment is the reliance on centralized authorities. Stablecoin tasks that use fiat cash as collateral depend on belief within the mission to keep up U.S. greenback escrow. In distinction, these relying on overcollateralized crypto belongings are topic to market dangers. Sadly, flatcoin tasks nonetheless want to supply an answer to this drawback.
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 accessible CPI information printed by the Bureau of Labor Statistics alone would restrict the true potential of flatcoins. Initiatives comparable to Chainlink and (my very own) IoTeX’s W3bstream have the potential to supply real-time information that might make correct and well timed CPI information potential.
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The success of flatcoins will depend upon the continued innovation of oracle groups. A decentralized flatcoin index might considerably enhance current funding devices for hedging inflation threat if creators can obtain real-time CPI information.
Dangers and uncertainties
The widespread adoption of flatcoins and comparable cryptocurrencies is determined by their capacity 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 automobile?
Buyers, customers and regulators should rigorously look at new developments within the digital asset area. Understanding these cryptocurrencies’ true nature and potential is significant to figuring out whether or not they are going to change into dominant within the monetary panorama or stay an intriguing however area of interest funding possibility.
Flatcoins’ emergence highlights the continued pursuit of stability and decentralization within the digital asset enviornment. Though this new monetary instrument introduces an revolutionary 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 creator’s alone and don’t essentially mirror or symbolize the views and opinions of Cointelegraph.
