The post-COVID-19 period has introduced the difficulty of inflation to the forefront, resulting in growing curiosity inside the Web3 area for creating flatcoins, an in depth “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 concept behind flatcoins could seem interesting, they increase vital reservations conceptually and by way of design. In the end, the success of flatcoins will rely upon whether or not builders can ship on their promise.
To this point, flatcoin white papers — together with the one supplied by Coinbase — don’t seem to ship on their envisioned promise, a minimum of of their present state. Specifically, the token economics designs of some tasks are more likely to pose an excellent increased threat than modern stablecoin designs.
Issues on the conceptual stage
Analyzing the potential use instances of flatcoins is certainly essential. Whereas typically offered 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 similar as that of fiat currencies. In distinction, flatcoins are indexes of the shopping for energy of a fiat forex obtained via 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 forex they observe over time so long as inflation just isn’t zero. Due to this fact, the existence of flatcoins will depend on the belief 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 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 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 buyers can simply entry TIPS and achieve publicity to inflation via exchange-traded funds (ETFs) of their brokerage accounts.
The supply of those established inflation-linked asset lessons via 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 carry 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 might enable for extra environment friendly monetary transactions and creates competitors with conventional monetary intermediaries comparable to 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 in the present day.
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 continues to be in its infancy and faces vital challenges.
A number of tasks are presently in progress which can be growing CPI-indexed flatcoins, however these tasks depend on mechanisms just like stablecoins. Some current flatcoin designs, comparable to Frax Worth Index Share (FPIS) and Reflexer’s Rai Reflex Index (RAI), algorithmically regulate the availability of the flatcoin to take care of the peg to a selected purchasing-power-related index, just like how algorithmic stablecoins hold their pegs to fiat currencies.
Nevertheless, 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 Worth Index (FPI) states:
“Throughout occasions that AMO yield is underneath 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 widespread in algorithmic stablecoins. If the protocol runs out of reserve Frax Worth Index Share (FPIS) tokens, a run just like Terra’s will seemingly occur.
Moreover, as inflation hardly ever goes unfavourable, fixed gross sales of FPIS tokens will probably be obligatory to take care of the 100% collateral ratio, making this design much more prone 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 venture 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 drawback.
One other important barrier to growing an efficient buying energy index with flatcoins lies within the accuracy of the info offered by oracle protocols. Counting on publicly accessible CPI information revealed by the Bureau of Labor Statistics alone would restrict the true potential of flatcoins. Tasks comparable to Chainlink and (my very own) IoTeX’s W3bstream have the potential to offer real-time information that would make correct and well timed CPI information attainable.
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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 information.
Dangers 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 affect on the broader monetary ecosystem is essential. Do they supply a extra secure and decentralized different to conventional currencies, or are they only one other funding automobile?
Buyers, customers and regulators should fastidiously 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 may change into dominant within the monetary panorama or stay an intriguing however area of interest funding choice.
Flatcoins’ emergence highlights the continued pursuit of stability and decentralization within the digital asset enviornment. Though this new monetary instrument introduces an modern method, it carries extra dangers and uncertainties. Buyers, customers and regulators can higher navigate the way forward for inflation-indexed cryptocurrencies by sustaining a important 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 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 below are the writer’s alone and don’t essentially replicate or symbolize the views and opinions of Cointelegraph.
