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Flatcoiners should follow the fate of TerraUSD

Published on

April 15, 2023
Read Time:6 Minute, 36 Second

The post-COVID-19 period has introduced the problem of inflation to the fore, resulting in elevated curiosity within the Web3 house in creating flatcoins, an in depth "cousin" of stablecoins, designed to mitigate the chance of inflation.

Many present flatcoins, like TerraUSD (UST) stablecoin from Terra, are algorithmically backed and thus function a stark reminder of the dangers related to algorithmic backing, because the collapse of LUNA and UST demonstrated. As tempting as the thought behind flatcoins could also be, they increase appreciable conceptual and design reservations. In the end, the success of flatcoins will rely on whether or not builders can ship on their promise.

Up to now, flatcoin whitepapers — together with the one provided by Coinbase — aren't delivering on their meant promise, a minimum of of their present state. Specifically, the token financial system designs of some tasks are prone to pose a fair increased threat than fashionable stablecoin designs.

issues on the conceptual stage

Exploring the potential use instances of flatcoins is certainly essential. Though this notion is usually offered as an asset that may assist customers preserve their buying energy amidst inflation and financial uncertainty, this notion could possibly be deceptive.

Stablecoins are digitized variations of fiat currencies, and their worth as a medium of trade and unit of account is similar as fiat currencies. In distinction, flatcoins are indices of a fiat foreign money's buying energy, obtained via oracles that acquire knowledge on financial indicators equivalent to the patron worth index (CPI).

Associated: CBDCs will result in absolute authorities management

Because of this, so long as inflation just isn't zero, flatcoins' face worth will diverge from the fiat foreign money they monitor over time. Subsequently, the existence of flatcoins depends upon the belief that fiat currencies or their digitized types are the medium of trade and unit of account.

In different phrases, there can be no state of affairs the place flatcoins are higher than stablecoins or fiat currencies as a medium of trade and unit of account, because the existence of flatcoins depends upon the supremacy of fiat currencies and stablecoins in these roles.

Inflation-linked property exist already

Flatcoins are monetary devices that expose buyers to inflation charges, making them a spinoff of inflation. Asset courses that expose buyers to inflation threat have been round for a very long time.

For instance, Treasury Inflation-Protected Securities (TIPS) have been used since 1997 to handle inflation dangers related to mounted earnings. Retail buyers can simply entry TIPS and expose themselves to inflation via trade traded funds (ETFs) of their brokerage accounts.

The supply of those established inflation-linked asset courses through ETFs implies that institutional and retail buyers can simply handle their inflation threat. The potential worth proposition of flatcoins as an inflation hedging funding car could also be restricted.

Regardless of some criticism of flatcoins, they've the potential so as to add worth to the financial system. The true innovation of flatcoins lies of their integration of conventional monetary devices into the blockchain. Flatcoins are a digitization of an present asset class, much like how stablecoins digitize fiat currencies. This innovation can allow extra environment friendly monetary transactions and creates competitors with conventional monetary intermediaries equivalent to TIPS ETFs, probably resulting in better efficiencies and decrease prices in monetary markets. Nonetheless, it is very important notice that the existence of flatcoins just isn't the salvation for the macroeconomic challenges we face as we speak.

Design stage points

Discussions to this point have revolved across the potential makes use of and improvements of Flatcoins. Nonetheless, it is very important word that the present growth of an inflation-linked stablecoin remains to be in its infancy and faces vital challenges.

There are presently just a few tasks working that develop CPI-indexed flatcoins, however these tasks depend on related mechanisms as stablecoins. Some present flatcoin designs, equivalent to Reflexer's Frax Worth Index Share (FPIS) and Rai Reflex Index (RAI), algorithmically modify the availability of flatcoins to take care of pegging to a particular buying power-related index, very similar to algorithmic stablecoins modify their pegs in fiat currencies.

Nonetheless, algorithmic stablecoins have confirmed to be a dangerous design class, as excessive market situations can set off a bankrun-like downward spiral, as seen within the case of the Terra collapse.

For instance, Frax Finance's white paper on the Frax Worth Index (FPI) pegging mechanism conditions:

“Throughout occasions when the AMO yield is beneath the CPI charge, promote a TWAMM-AMO FPIS token for FRAX stablecoins to maintain the CR at 100% always.”

To place it merely, the protocol will promote index tokens for the Frax Finance stablecoin if the return on the CPI index falls beneath its precise worth. Nonetheless, this design suffers from a weak point widespread to algorithmic stablecoins. If the protocol runs out of FPIS (Reserve Frax Worth Index Share) tokens, it is going to possible see a run much like Terra.

Moreover, since inflation not often goes adverse, fixed gross sales of FPIS tokens are required to take care of the 100% collateral ratio, making this design much more inclined to runs than different algorithmic stablecoin designs.

Frax white paper describing the "stability" mechanism

The trade-off of counting on something aside from algorithmic customization is reliance on centralized authorities. Stablecoin tasks utilizing fiat cash as collateral depend on belief within the venture to take care of US greenback escrow. In distinction, these depending on over-collateralized crypto property are topic to market threat. Sadly, Flatcoin tasks have but to supply an answer to this drawback.

One other important impediment to growing an efficient buying energy index utilizing flatcoins lies within the accuracy of the information offered by Oracle logs. Relying solely on publicly obtainable CPI knowledge launched by the Bureau of Labor Statistics would restrict the true potential of flatcoins. Initiatives like IoTeX's Chainlink and (my very own) W3bstream have the potential to supply real-time knowledge that might allow correct and well timed CPI knowledge.

Associated: The world might face a darkish future because of CBDCs

The success of flatcoins will rely on the continual innovation of the oracle groups. A decentralized flatcoin index might drastically improve present funding instruments for hedging inflation threat if creators can obtain real-time CPI knowledge.

dangers and uncertainties

The widespread adoption of flatcoins and related cryptocurrencies depends upon their skill to beat the inherent challenges and dangers of stablecoin designs.

As flatcoins and different inflation-indexed cryptocurrencies emerge, assessing their influence on the broader monetary ecosystem is essential. Do they provide a extra secure and decentralized different to conventional currencies, or are they simply one other funding car?

Traders, customers and regulators have to rigorously take into account new developments within the discipline of digital property. Understanding the true nature and potential of those cryptocurrencies is essential in figuring out whether or not they'll dominate the monetary panorama or stay an intriguing however area of interest funding choice.

The emergence of flatcoins underscores the continued quest for stability and decentralization within the digital asset house. Though this new monetary instrument introduces an modern strategy, it carries further dangers and uncertainties. Traders, customers, and regulators can higher steer the way forward for inflation-indexed cryptocurrencies by maintaining a important eye on these developments.

Peter Han has a PhD in Finance from the College of Illinois Urbana-Champaign with a deal with monetary intermediation and fintech, along with a grasp's diploma in monetary engineering. He has a BA in English and a BS in Arithmetic from Tianjin College, China. 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 basic informational functions and shouldn't be construed as authorized or funding recommendation. The views, ideas, and opinions expressed herein are solely these of the creator and don't essentially replicate or characterize the views and opinions of Cointelegraph.

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Azeez Mustafa
Azeez began his FinTech career path in 2008 after growing interest and intrigue about market wizards and how they managed to become victorious on the battlefield of the financial world. After a decade of learning, reading and training the ins and outs of the industry, he’s now a sought after trading professional, technical/currency analyst and funds manager – as well as an author.
Last Updated : April 15, 2023
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