Flatcoins: the best defense against inflation?
We explain how they work and how they differ from stablecoins
Flatcoins are a type of stablecoin that is not tied to a specific asset or fiat currency, but changes according to the movement of inflation. The value of a flatcoin should remain constant in terms of what can be bought with it.
So, stablecoins can hedge against inflation by limiting supply, but as long as a coin is pegged to real-world assets (RWA), it will be vulnerable to price increases that affect return on investment (ROI). Therefore, there was a need to create an inflation-protected, stablecoin tied to the cost of living.
The term “flatcoin” was first mentioned by Balaji Srinivasan, the former CTO of the US crypto exchange Coinbase, in 2021.
How flatcoins work
Developers have tried to implement flatcoins in different ways. One approach is to use a basket of assets, while others include smart contracts and seigniorage systems.
Basket of assets
In this approach, developers use cost-of-living indices, such as the US Federal Bureau of Statistics Consumer Price Index (CPI) or Truflation, based on the blockchain oracle of the same name, to calculate the value of the flatcoin on a daily basis and adjust the coin’s supply accordingly.
Using a basket of assets to collateralize a flatcoin is a relatively simple and straightforward approach that, in some ways, replicates the ways fiat currencies are valued. However, it comes with some difficulties:
- Asset selection: The composition of the basket must accurately reflect the cost of living, otherwise the value of the flatcoin may be unstable.
- Asset liquidity: The assets in the basket must always be easy to buy and sell, otherwise the value of the flatcoin will also be unstable.
- Asset Risk: The assets in the basket should be low risk. A higher risk increases the likelihood that the flatcoin will be volatile.
- Transparency: The issuer must disclose the composition of the basket and how the assets are managed, this is important to build investor confidence.
- Regulation: Many countries lack a regulatory framework for stablecoins in general and for non-fiat-pegged ones in particular. Compliance may make it more difficult and expensive to implement the flatcoin.
The smart contract at the heart of the flatcoin is programmed to adjust its supply depending on changes in the cost-of-living index. Thus, when the index rises, the smart contract automatically issues more flatcoins, and when it falls, it burns them.
This approach is very promising because it does not depend on a central authority to manage the supply, thus reducing volatility. However, there are a number of difficulties in using smart contracts to launch flatcoins:
- Security: Smart contracts are inherently transparent. Because anyone can see the code, contracts are often targeted by hackers. If a flatcoin smart contract is hacked, it could be used for unauthorized coin issuance/burning, destabilizing the exchange rate.
- Complexity: It can be expensive to hire developers skilled in writing complex smart contracts that are both secure and efficient.
- Data source: Smart contracts need a reliable, tamper-proof source to provide accurate, up-to-date cost-of-living data. Typically, oracles are used for this purpose, which creates additional potential points of failure. According to Forbes, oracle attacks cost investors $362 million last year.
- Scalability: Smart contracts are difficult to scale while maintaining high throughput. This could make it difficult to use flatcoins for everyday payments, and as a result, limit their adoption.
- Governance: There is no clear governance structure for smart contracts. This can make it difficult to make changes to the smart contract or resolve disputes.
- Regulation: Smart contracts are a fairly new technology and there is no clear regulatory framework for them.
Flatcoins of this type are issued by a central authority, which then collects revenue from the use of the coin. The revenue collected is used to redeem and destroy the coins in order to maintain their supply. This approach can be implemented with or without the use of smart contracts.
Nuon is a decentralized coin issued using a smart contract based on the Ethereum blockchain. It uses the Truflation index to adjust the exchange rate
Spot is a project of the Ampleforth Foundation. The coin’s exchange rate is pegged to the living wage in the United States.
International Stable Currency (ISC) is pegged to the value of a basket of real assets that does not include the US dollar.
Collypto uses a tokenized index of real estate and commodities as collateral.
LendrUSD (USDL) is a coin pegged to a proprietary oracle that uses over 18 million data points from 30+ verified sources to calculate the inflation rate.
To keep up with inflation rates, flatcoins must have enough assets through appreciation and new investments to offset losses arising from investor withdrawals or asset depreciation.
One approach is to invest collateral in protocols such as Aave and Convex to cover the cost of inflation. By providing collateral, flatcoin developers earn interest, which can then be used to redeem and destroy coins. This keeps the supply of flatcoins in check and preserves their value.
Another approach is for issuers to invest collateral in new assets that contribute to the value of the flatcoin.
While the development of inflation-pegged stablecoins is still in its infancy, issuers are actively experimenting with methods to preserve purchasing power and face regulatory challenges.
In February, for example, the Frax Finance community approved full collateralization of its flatcoin after the Canadian regulator CSA announced a ban on issuing non-fiat-backed stablecoins. In August, Coinbase CEO Brian Armstrong brought up the idea of flatcoins again while promoting the first annual Coinbase Ventures Summit. He is credited with renewing interest in such coins, a concept that continues to gain momentum despite its current problems.
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