The post-COVID-19 period has introduced the problem of inflation to the forefront, resulting in growing curiosity inside 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 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 seem interesting, they increase vital reservations conceptually and when it comes to design. In the end, the success of flatcoins will depend upon whether or not builders can ship on their promise.
Thus 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 greater threat than up to date stablecoin designs.
Issues on the conceptual degree
Inspecting the potential use circumstances 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 could possibly be deceptive.
Stablecoins are digitized variations of fiat currencies, and their worth as a medium of change 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 information on financial indicators such because the Shopper Worth Index (CPI).
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Consequently, the unit worth of flatcoins will diverge from the fiat forex they observe over time so long as inflation isn’t zero. Due to this fact, the existence of flatcoins is dependent upon the belief that fiat currencies or their digitized kinds are the mediums of change and items 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 change 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 spinoff of inflation. Asset lessons that expose traders to inflation threat have been round for a very long time.
As an illustration, 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 achieve publicity to inflation by exchange-traded funds (ETFs) of their brokerage accounts.
The supply of those established inflation-linked asset lessons by ETFs implies that institutional and retail traders can simply handle their publicity to inflation. The potential worth proposition of flatcoins as an funding car for inflation hedging could also be restricted.
Regardless of 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, much like how stablecoins digitize fiat currencies. This innovation might 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. Nonetheless, it’s important to acknowledge that the existence of flatcoins 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. Nonetheless, it’s important to notice that the present improvement of an inflation-pegged stablecoin continues to be in its infancy and faces vital 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, akin to 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 maintain their pegs to fiat currencies.
Nonetheless, 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 beneath 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 beneath its precise worth. Nonetheless, this design poses a vulnerability widespread in algorithmic stablecoins. If the protocol runs out of reserve Frax Worth Index Share (FPIS) tokens, a run much like Terra’s will seemingly occur.
Moreover, as inflation hardly ever goes unfavorable, fixed gross sales of FPIS tokens can be mandatory 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 undertaking 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 supply an answer to this downside.
One other crucial 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 revealed by the Bureau of Labor Statistics alone would restrict the true potential of flatcoins. Tasks akin to Chainlink and (my very own) IoTeX’s W3bstream have the potential to supply real-time information that would 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 dependent upon their potential 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 steady and decentralized different to conventional currencies, or are they only one other funding car?
Buyers, customers and regulators should fastidiously study new developments within the digital asset area. Understanding these cryptocurrencies’ true nature and potential is significant to figuring out whether or not they may 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 area. Though this new monetary instrument introduces an modern method, it carries further dangers and uncertainties. Buyers, customers and regulators can higher navigate the way forward for inflation-indexed cryptocurrencies by sustaining a crucial 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 geared toward enhancing IoTeX’s tokenomics design.
This text is for common data functions and isn’t supposed 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.
