The Rise of Flatcoins - Addressing Inflation Through Stablecoins
I. Introduction
A. What is Flatcoins?
Flatcoins are an emerging type of inflation-resistant stablecoin designed to track changes in inflation over time rather than being pegged to a single currency. The goal of flatcoins is to conserve the purchasing power of token holders and platform users by adjusting the token's valuation according to inflation metrics.
Proposed in 2021, flatcoins - also referred to as value stablecoins or purchasing power stablecoins - aim to remain steady in purchasing power even during periods of rising inflation. As explained by Balaji Srinivasan, the former Coinbase CTO who coined the term, flatcoins are pegged to indices like the Consumer Price Index in order to sustain their real value as a store of wealth. This provides users with a more stable store of value compared to holding currencies that face inflationary depreciation over the long run. By tracking economic indicators of inflation, flatcoins hope to keep value stable for holders through changing economic conditions.
Afterward, Laguna Labs, a company at the forefront of blockchain innovation, introduced Nuon, their latest cryptocurrency creation. They're claiming it as the world's first over-collateralized and decentralized "flatcoin" with a hint of pride in their announcement.
B. What is Inflation?
In the realm of web3, there's often a bit of confusion around the term "inflation," which typically refers to the expanding token supply. Traditionally, economists would call this phenomenon "dilution".
Inflationary environments can erode the purchasing power of currency holders, leading to a loss of trust in the currency and the broader economic system. That's why inflation is closely watched as a key metric of any economy, with central banks globally aiming for low annual inflation rates (usually around 2 to 4 percent). Yet, recent global economic trends have shown that achieving this goal is anything but simple.
In response to the recent inflationary pressures worldwide, Coinbase has proposed the concept of an inflation-adjusted 'flatcoin' (Prices-OECD Data, 2023; Lindrea, 2023). The idea behind a flatcoin is to maintain stable purchasing power while offering resilience against economic uncertainties stemming from the legacy financial system. But as always, the devil's in the details - let's dive into some of the challenges inherent in designing a flatcoin.
II. Flatcoins Design Challenges
Designing flatcoins presents a unique set of challenges, each requiring careful consideration and resolution. These challenges revolve primarily around accurately sensing inflation and creating appropriate incentives. Inflation, operating within complex adaptive systems, involves myriad dynamic interactions and unpredictable human behaviors, complicating flatcoin design. Some key considerations include:
III. Flatcoins vs Other Stablecoins
Stablecoins come in various forms, each with distinct characteristics and underlying mechanisms. Let's explore the main types of stablecoins and compare them to flatcoins:
In terms of design and implementation, flatcoins may necessitate more intricate economic models and algorithms to accurately track inflation changes and adjust value accordingly. Additionally, flatcoins may encounter more complex regulatory hurdles, particularly concerning the accuracy and fairness of inflation data.
IV. Distributed Control Challenge
Understanding inflation comprehensively poses a challenge due to its spatial, temporal, and compositional complexities. This challenge parallels the design complexities of distributed control systems.
In control theory terms, the flatcoin design challenge can be conceptualized as follows:
1. The market for goods and services acts as a geographically distributed 'plant', emitting diverse price signals across different locations and times.
2. Designing appropriate sensors becomes crucial to capture relevant signals at the right frequency and locations, which are then fused on suitable temporal and spatial scales.
3. These signals are then processed by a controller to construct a comprehensive model of the world, aiming to estimate necessary market interventions for the flatcoin value to align with expectations.
4. Actuators are essential components to incentivize adjustments in the secondary market, ensuring the flatcoin value remains in line with inflation.
In the following section, we'll delve into the fundamentals of control theory to further dissect this design challenge.
A. Describing the Environment
In the world of control theory, defining the boundaries or environment of a system is crucial. It's like creating a map that helps us understand and navigate within that system. Let's delve into the components of a control system:
Plants are the systems we aim to control, whether they're mechanical setups, electrical circuits, or even biological organisms. Originally, the term "plants" referred to factories and production facilities equipped with sensors for temperature control.
Sensors are like the senses of the system, measuring various aspects of the plant's behavior or surroundings, like temperature, pressure, or the prices of goods and services in different locations. They help us keep track of changes, like shifts in inflation.
Actuators are the movers and shakers, influencing the future behavior of the plant. They could be motors, valves, heaters, or even economic incentives, ensuring that the prices of inflation-adjusted tokens evolve appropriately.
Controllers are the brains behind the operation, processing information from sensors and orchestrating actions from actuators to achieve desired outcomes. They use algorithms and mathematical models to steer the system towards its goals, even in the face of unpredictable human interactions.
Together, sensors, actuators, and controllers form the core of a control system for a plant, enabling us to regulate and automate various processes. It's like having a team of experts working together to keep things running smoothly, adapting to changes as needed.
V. Inflation: A Multi-Faceted Challenge
Tokens designed to counteract the effects of inflation on purchasing power face a significant hurdle: determining which sensors and information sources to rely on. Questions like "Where is inflation occurring?", "Who is affected?", and "Which goods and services are involved?" must be addressed thoughtfully.
As economist Blair Fix eloquently illustrates, inflation isn't a simple, singular concept. While we have indices like the GDP deflator or the Consumer and Producer Price Indices (CPI and PPI), each metric varies considerably and depends on factors like location, industry, or sector. These indices often lack temporal granularity, getting updated monthly at best, despite changes in purchasing power impacting daily life, like groceries or gas purchases.
Designing a flatcoin, meant to maintain a consistent purchasing power despite price fluctuations, requires careful consideration of its intended scope and reach. Such an inflation-adjusted token must navigate varying levels of price volatility, like hyperinflation in certain regions or sectors, while also addressing low volatility and inflation absence elsewhere.
Furthermore, selecting the right inflation measure poses challenges, as inflation can vary greatly even within a nation, region, or city. Standardized measures like the CPI overlook differences in purchasing power across different professions, investments, and socio-economic groups.
Implementation adds another layer of complexity to the design challenge. Accurately and promptly measuring inflation presents a daunting oracle problem, considering the vulnerability of such a token to manipulation. Since the actuators of the flatcoin system rely on the reliability and integrity of the oracle subsystem, their design is far from straightforward.
VI. Towards Flatcoins in Production
Designing an inflation-resistant cryptocurrency is no small task. As I've thought about this problem, the spatial and temporal dimensions alone present significant challenges. However, some of the open issues seem like intriguing puzzles that control theory could help solve in order to develop the proper incentives for an algorithmically regulated token economy.
Rather than trying to tackle everything at once, my recommendation would be to start small with a minimal proof-of-concept (PoC) and implement it in an agile fashion. This would allow us to achieve some initial goals and satisfy basic requirements without getting too far ahead of ourselves. The PoC could be designed to easily incorporate new features as we continue solving design problems through iterative development and priority-setting.
One approach I've considered is constraining the spatial component of inflation initially. A simple PoC design could focus on a single currency market using a regional index and scalar price level, though basic arbitrage issues would still need to be addressed. Longer term, a global composite index may solve those arbitrage problems and unlock more robust use cases. However, properly accounting for diverse multi-spatial data points at a worldwide scale would require significantly more design work to navigate the myriad challenges laid out here.
By deploying and evaluating an initial PoC, we could develop additional specifications and directions for the sensors, controllers, and systems necessary to implement an effective flatcoin solution more broadly. This staged approach seems prudent as the research and development of such a globally comprehensive inflation token would incorporate considerable conceptual and technical hurdles. Breaking the problem down into achievable phases feels like the most productive path forward.
VII. Typical Project Analyses
A. Reserve Protocol
I've been really intrigued by this Reserve Protocol project and their vision for creating a stablecoin called Reserve Token (RSV). Their goal is ambitious - to develop a digital currency that allows people to make purchases and exchanges like regular fiat money, but without the inflation and volatility issues we see with things like the US dollar or cryptocurrencies such as Bitcoin.
To accomplish this, Reserve has come up with some clever technical mechanisms. They use a dual-token system of RSV and Reserve Rights (RSR) where RSR tokens help maintain RSV's stability. Collateral assets back the RSV as well to support its value peg. I think the governance aspect of RSR tokens restoring the peg when needed is a nice solution.
It seems Reserve is really thinking through how to build something that can weather inflationary economic storms. Their diversified collateral approach and decentralized structure also aim to reduce single points of failure. Overall, their design looks like it's geared towards creating a stable store of value for both the short and long run.
From the market data I've looked at, it seems the RSR token has had some healthy growth since its inception in 2020. It reached an all-time high over $0.11 in 2021 which is impressive considering it once traded under $0.001. At around $0.002 now, it seems there may still be room for RSR to appreciate if Reserve Protocol continues gaining traction. I'm interested to keep an eye on how their technology and the project progresses over time.
B. Frax Price Index (FPI)
I've been digging into this new stablecoin from Frax Finance called the Frax Price Index, or FPI for short. What really stood out to me is that unlike ones pegged to national currencies, FPI tracks inflation by linking its value to a basket of consumer goods based on the US CPI.
It uses Chainlink oracles to pull in the official monthly CPI inflation rate from the government and adjusts FPI's redemption price accordingly. So if inflation is 9.1% for a month, FPI increases its value by that same percentage over the next 30 days. What a cool way to tie a crypto's value directly to real-world goods prices.
From what I understand, FPI maintains a 100% collateralization ratio at all times through its Algorithmic Market Operations, similar to Frax's AMO system. This ensures the protocol's growth keeps pace with inflation. If returns fall short, it may need to sell some of its linked FPIS governance tokens.
C. Analysis of SPOT
SPOT strives to carve out a unique niche by resisting inflation without relying solely on speculation or traditional currencies. Its distinct value proposition raises questions worth exploring as innovative models like this test new stablecoin directions. The team is building SPOT on top of the Ampleforth and Buttonwood protocols, which aims to provide a more stable and reliable unit of account for the cryptocurrency ecosystem.
As a decentralized stablecoin, SPOT is designed to be resistant to inflation and volatility, making it an attractive alternative to the traditional US dollar alternatives. The unique zero-liquidation tranching mechanism keeps the price stable and reduces the volatility of the AMPL supply.
One of the things that I find most interesting about SPOT is its ability to be utilized and circulated across multiple chains, including Ethereum, Polygon, Arbitrum, Optimism, BNB Chain, and Polygon zkEVM. This cross-chain functionality makes SPOT a versatile and reliable asset that can be used in various blockchain ecosystems.
The SPOT protocol has several innovative features to address inflation:
- ERC-20 token and permanent wrapper: SPOT is an ERC-20 token that abstracts the supply volatility of AMPL, making it easier to hold and use as a stablecoin. It's designed to maintain a stable price similar to AMPL, which is pegged to the CPI-adjusted 2019 dollar.
- SPOT Rotator: This feature allows users to stake AMPL to support the SPOT Flatcoin, while maintaining the AMPL rebase mechanism and obtaining AMPL benefits. This mechanism is a decentralized flatcoin that uses tranching instead of liquidation markets to provide stability that scales.
I'm excited to see how SPOT will continue to evolve and grow in the decentralized finance ecosystem. With its unique features and cross-chain functionality, it has the potential to become a truly decentralized unit of account for the cryptocurrency ecosystem.
VIII. Conclusions
In conclusion, flatcoins offer a promising solution to combat inflation through stablecoins. While challenges exist in accurately measuring inflation rates and navigating regulatory landscapes, projects like Reserve Protocol, Frax Finance, and SPOT are pioneering innovative approaches to address these issues. By adopting a staged approach and fostering collaboration, the cryptocurrency community can drive further innovation and realize the full potential of flatcoins in reshaping the future of finance.