The post-COVID-19 period has introduced the problem of inflation to the forefront, resulting in growing curiosity inside the Web3 house 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 thought behind flatcoins could seem interesting, they elevate important reservations conceptually and when it comes to design. In the end, the success of flatcoins will rely on whether or not builders can ship on their promise.

Thus far, flatcoin white papers — together with the one provided 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 an excellent increased 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 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 Shopper Value 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 will not be zero. Due to this fact, the existence of flatcoins is dependent upon the idea that fiat currencies or their digitized varieties are the mediums of alternate 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 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 courses 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 acquire publicity to inflation by exchange-traded funds (ETFs) of their brokerage accounts.

The provision of those established inflation-linked asset courses 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.

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, much like how stablecoins digitize fiat currencies. This innovation might enable for extra environment friendly monetary transactions and creates competitors with conventional monetary intermediaries equivalent to TIPS ETFs, doubtlessly resulting in better effectivity and decrease prices in monetary markets. Nonetheless, it’s important to acknowledge that the existence of flatcoins will not be 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 growth of an inflation-pegged stablecoin remains to be in its infancy and faces important challenges.

A number of tasks are at present in progress which might be creating CPI-indexed flatcoins, however these tasks depend on mechanisms much like stablecoins. Some current flatcoin designs, equivalent to Frax Value 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 particular purchasing-power-related index, much like how algorithmic stablecoins preserve their pegs to fiat currencies.

Nonetheless, algorithmic stablecoins have confirmed to be a dangerous design class, as excessive market situations 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 Value 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 under its precise worth. Nonetheless, this design poses a vulnerability widespread in algorithmic stablecoins. If the protocol runs out of reserve Frax Value Index Share (FPIS) tokens, a run much like Terra’s will probably occur.

Moreover, as inflation hardly ever goes detrimental, fixed gross sales of FPIS tokens shall 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 aside 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 property are topic to market dangers. Sadly, flatcoin tasks nonetheless want to offer an answer to this downside.

One other vital barrier to creating an efficient buying energy index with flatcoins lies within the accuracy of the information offered by oracle protocols. Counting on publicly out there CPI knowledge revealed by the Bureau of Labor Statistics alone would restrict the true potential of flatcoins. Tasks equivalent to Chainlink and (my very own) IoTeX’s W3bstream have the potential to offer real-time knowledge that might make correct and well timed CPI knowledge doable.

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The success of flatcoins will rely on 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 knowledge.

Dangers and uncertainties

The widespread adoption of flatcoins and related cryptocurrencies is dependent 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 steady and decentralized various to conventional currencies, or are they simply one other funding car?

Traders, customers and regulators should fastidiously look at new developments within the digital asset house. Understanding these cryptocurrencies’ true nature and potential is important 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 continued pursuit of stability and decentralization within the digital asset enviornment. Though this new monetary instrument introduces an progressive strategy, it carries further dangers and uncertainties. Traders, customers and regulators can higher navigate the way forward for inflation-indexed cryptocurrencies by sustaining a vital eye on these developments.

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 below are the creator’s alone and don’t essentially replicate or signify the views and opinions of Cointelegraph.