TL;DR

l The rise of flatcoins: Digital stablecoins pegged to fiat currencies have been affected by the decline in purchasing power, which has led to the financial market’s strong interest in flatcoins that can truly maintain the stability of purchasing power in an inflationary environment. This new type of stablecoin resists inflation by being pegged to the price of a specific basket of goods. It is regarded by industry leaders, such as Vitalik Buterin and Coinbase CEO Brian Armstrong, as a significant direction for the future of finance.

l Definition of flatcoins: Unlike other stablecoins pegged to specific assets or fiat currencies, flatcoins are stablecoins designed to tackle inflation and maintain purchasing power. In countries experiencing soaring inflation rates, it serves as an effective tool against inflation and is used as a hedging strategy in highly inflationary regions such as Latin America and Africa.

l Design challenges of flatcoins: Accurately measuring inflation rates presents a challenge due to differences in measurement methods such as CPI and PPI in different countries and regions. It is necessary to rely on reliable and accurate data sources and ensure data verification and auditing; Overcoming manipulation, attacks, and market volatility necessitates high system stability and security; legal and regulatory differences among nations may impose additional restrictions and risks on stablecoin design and issuance; designing effective economic models ensures that stablecoins truly reflect inflation; technically, real-time processing of inflation data, designing stable smart contracts, and ensuring system efficiency are crucial; market acceptance and user education are also critical for success.

l Significance of flatcoins in the crypto market: Flatcoins could protect the purchasing power of users in high-inflation environments, provide stability, and are more reliable than traditional stablecoins. They also drive technological innovation, enhancing the utility of digital currencies, attracting more traditional financial participants, and helping foster a clear regulatory environment. Additionally, they provide diverse options to the market and offer new risk management tools for the global economy.

l Typical project analysis: Frax Price Index (FPI), Frax Finance’s stablecoin pegged to CPI-U with full cryptographic collateral; the Reserve project aims to create a decentralized stablecoin Reserve Token (RSV) to reduce risks through diversification; SPOT, based on Ampleforth and Buttonwood, aims to bridge the gap between speculative cryptocurrencies and USD alternatives, utilize zero-liquidation tranching to provide stability, and can operate on multi-chain.

Why Do We Need Flatcoins?

Throughout history, currencies, as reflections of economic and national strength, have witnessed many transitions. Whenever a dominant power declines and is replaced by an emerging power, its dominant monetary position also changes accordingly.

The Dutch guilder had been dominant during its economic peak, and the pound sterling during the British Empire became a globally trusted currency. However, none of these currencies have been able to maintain their leading positions permanently.

Recently, Ray Dalio, founder of Bridgewater Associates, proposed that the US dollar’s ​​status as the world’s reserve currency may be challenged. He emphasized in an interview in 2023 that as the US dollar’s global influence weakens and the international economic and monetary landscape shows a multipolar trend, the US dollar’s reserve currency status faces an uncertain future.

Since January 2020, the average purchasing power of Americans has declined by 23.90%

(Source: https://truflation.com/)

In the three years from October 10, 2020 to October 10, 2023, Truflation data shows that the average purchasing power of Americans has decreased by 20.39%. This means that for those who hold assets exclusively in U.S. dollars, their ability to buy goods in the market has shrunk by one-fifth over those three years.

However, this inflationary phenomenon is not unique to the United States. Data from the International Monetary Fund (IMF) predicts that global inflation rate will be 6.6% in 2023, compared with 8.8% in 2022. The World Economic Forum further pointed out that the global economy is facing a sustained period of high inflation due to the impact of complex factors such as deglobalization, climate change, wage-price spirals, and highly liquid global markets.

Some countries, such as Argentina, Turkey and Iran, have experienced extremely high inflation rates of 76.1%, 51.2% and 40.0% respectively in 2023 due to political instability, international sanctions, monetary policy mistakes and economic management issues.

In the field of digital currency, although traditional stablecoins are designed to be pegged to specific fiat currencies or assets to maintain their stability, the corresponding digital stablecoins have also been affected by the inflation of fiat currencies. From the birth of the first batch of stablecoins in 2014 to their widespread adoption with the rise of decentralized finance (DeFi) in 2017, stablecoins like Tether (USDT) and USD Coin (USDC) have become the world’s third and fourth-largest cryptocurrencies by market capitalization respectively. Currently, there are approximately 200 stablecoins in the market with a total market value of $190 billion.

However, stablecoins like USDT and USDC primarily operate in a centralized manner, posing risks associated with central entity control and exposing holders to counterparty and regulatory risks.

More importantly, as global inflation continues to rise, the real value of these stablecoins pegged to fiat currencies such as the US dollar is suffering losses.

Relative purchasing power index of USD (compared to the initial issuance period)

(Source: howmuch.net)

This indicates that stablecoins are not necessarily truly “stable”, which seems unreasonable but is an existing dilemma. With rising inflation and uncertainty in the global economy, financial markets, especially the crypto market, have begun to seek a new type of stablecoin that can maintain purchasing power and remain stable even in an inflationary environment. Anti-inflation stablecoins (also known as flatcoins) emerged at the historic moment and became a new focus in the market.

Flatcoin emerged as a decentralized stablecoin with the purpose of protecting assets from the impact of inflation. Unlike traditional stablecoins, Flatcoin protects purchasing power by protecting against inflation by maintaining a peg to the price of a specific basket of goods. Since the conceptualization of Flatcoin, it has garnered significant attention within the crypto industry. Flatcoin’s stated goal is to “maintain stable purchasing power while also being resilient to resist the economic uncertainty caused by the traditional financial system.”

At the end of 2022, Vitalik Buterin, the co-founder of Ethereum, shared his outlook on the cryptocurrency industry in 2023 in an interview with Bankless, mentioning three “huge” opportunities that have not yet been realized in the crypto space: mass wallet adoption, inflation-resistant stablecoins and Ethereum-powered website logins.

Vitalik believes that creating a stablecoin capable of withstanding various conditions, including the hyperinflation of the US dollar, would present immense opportunities for the entire crypto industry. He emphasized that offering a reliable, inflation-resistant stablecoin to billions of users would be a crucial supplement to traditional financial systems.

Coinbase CEO Brian Armstrong has also mentioned flatcoin multiple times in public interviews and discussed the new technology on Twitter, ranking it at the top of the 10 crypto technologies.

Brian sees flatcoin as the future direction of stablecoin evolution. Unlike traditional fiat-pegged stablecoins, flatcoin provides a new, more stable store of value by tracking inflation. He also emphasized that although Coinbase has not yet ventured into this area, they have expressed strong interest in the possibility of this new type of stablecoin.

What are Flatcoins?

Inflation-resistant stablecoins, commonly referred to as flatcoins (also known as value stablecoins or purchasing power stablecoins), are designed to track inflation rates rather than being pegged to a specific currency.

The term “flatcoin” was first proposed in 2021 by Balaji Srinivasan, the former Chief Technology Officer of Coinbase. The purpose of flatcoins is to keep purchasing power stable and maintain its value even in an inflationary environment. They are pegged to the Consumer Price Index (CPI) or other inflation indicators, aiming to sustain their real value and providing users with a more stable and reliable way to store value.

Later, blockchain technology development company Laguna Labs launched a new cryptocurrency called Nuon. They assert this to be the world’s first over-collateralized and decentralized “flatcoin”.

Just as decentralized protocols address the risks associated with centralized currencies, overcollateralization stands as a means to retain value during market collapses, and flatcoins provide a solution for maintaining value over time.

With the rise in inflation rates—such as the United States reaching an 8.5% inflation rate in 2022, significantly surpassing the Federal Reserve’s 2% inflation target—flatcoins have become an appealing option. They typically face fewer restrictions than bank deposits and often offer higher interest rates, making them an attractive choice in the face of inflation.

In Latin America, inflation rates reached 14.6% in 2022 and were expected to reach 9.5% in 2023. In these high-inflation countries, utilizing flatcoins can serve as a hedge against high inflation and facilitate cross-border remittances across different countries and regions.

Flatcoins vs Other Stablecoins

Stablecoins can be classified mainly based on their underlying assets or operating mechanisms. Let’s take a look at the main stablecoin types with their characteristics and examples:

1. Commodity-backed Stablecoins:
   They are usually backed by hard assets such as gold or real estate to maintain the value of the stablecoin. For example, PAX Gold (PAXG) is a gold-pegged stablecoin, with each PAXG representing one ounce of gold.

2. Crypto-backed Stablecoins:
   The value of stablecoins is typically maintained by overcollateralizing crypto assets. For example, DAI is a crypto-backed stablecoin issued by MakerDAO, pegged to the US dollar but collateralized with cryptocurrencies like Ethereum to retain its stable value.

3. Fiat-backed Stablecoins:
   They are typically pegged at a 1:1 ratio to a specific fiat currency like the US dollar, euro, or Chinese yuan. Examples include USDT (Tether) and USDC (USD Coin), both pegged 1:1 to the US dollar.

4. Algorithmic Stablecoins:
   Algorithmic stablecoins typically use algorithms to regulate their supply and maintain stable value. For instance, Ampleforth (AMPL) adjusts its supply dynamically based on market demand.

The main purpose of flatcoins is to protect purchasing power and avoid the impact of inflation by maintaining a peg to an inflation index (such as CPI). However, other types of stablecoins typically keep their value stable by pegging to a specific asset or using algorithms.

In terms of design and implementation, flatcoins may require more complex economic models and algorithms to accurately reflect changes in inflation and adjust their value accordingly. At the same time, flatcoins may also face more complex regulatory challenges, especially regulatory requirements related to the accuracy and fairness of inflation data.

Challenges of Flatcoins’ Design

Designing flatcoins is a very challenging task both technically and economically. Its aim is to maintain the purchasing power of the stablecoin in an inflationary environment. However, there are still many challenges in designing mechanisms for flatcoins:

1.Accurate Measurement of Inflation Rate:

The inflation rate stands as a pivotal factor influencing the design of flatcoins. Inflation rates can vary across different countries and regions, which requires designers to find an accurate and reliable method to measure inflation. Inflation can be measured in a variety of ways, such as the Consumer Price Index (CPI), Producer Price Index (PPI) or other inflation indicators. However, these indicators may be affected by a variety of factors, including political factors, economic policies and different statistical methods, which can affect the accuracy and effectiveness of flatcoins.

For example, in a use case of Volt Protocol, its native stablecoin VOLT remains stable by pegging to the Consumer Price Index (CPI). If inflation remains at 7% for one year, the token will be pegged at $1.07.

2.Data Source Reliability:

The design of flatcoins relies heavily on reliable and accurate data sources. If the data source is inaccurate or unreliable, it may cause the value of flatcoins to deviate from the actual inflation rate, causing it to lose its anti-inflation characteristics. Designers need to find reliable data providers and ensure data accuracy and timeliness. In addition, robust data verification and auditing mechanisms need to be established to ensure data authenticity and integrity.

3.System Stability and Security:

Any cryptocurrency project, especially a stablecoin project, must consider the stability and security of the system. The design of flatcoins should consider how to prevent manipulation, attacks, and other factors that may affect the stability and security of the system. In addition, it is also necessary to consider how to design robust protocols and mechanisms to cope with market fluctuations and unforeseen events to ensure the continued stable operation of the system.

For example, on May 10, 2022, the price of TerraUSD, an algorithmic stablecoin running on the Terra blockchain, dropped and lost its peg to the U.S. dollar. This case shows how algorithmic stablecoins are vulnerable to speculative attacks when the system is undercollateralized.

4.Legal and Regulatory Challenges:

Flatcoins may be affected by the legal and regulatory environments of different countries and regions. These laws and regulations could affect the design, issuance and trading of flatcoins. Some countries may restrict or prohibit the use of flatcoins, or require project parties to meet specific regulatory requirements. These legal and regulatory challenges can increase the complexity and risk of a project.

At the end of 2019, when stablecoins were just emerging, the G7 summit strongly stated the serious risks they would pose for international settlements. This shows the impact of the legal and regulatory environment on the design and application of stablecoins. In September 2023, the G20 Summit approved the Financial Stability Board’s recommendations regarding the regulation, supervision, and oversight of crypto-asset activities and markets, including global stablecoin arrangements. More regulatory requirements are anticipated to be rolled out gradually.

5.Economic Model Design:

The economic model of flatcoins is the basis for ensuring their functionality and effectiveness. Designers need to consider how to build an effective economic model to ensure that the value of flatcoins accurately reflects the inflation rate. This may include determining their issuance mechanism, circulation mechanism and burning mechanism, as well as adjusting their value through market mechanisms.

6.Complexity of Technical Implementation:

The technical implementation of flatcoins is a complex process that requires consideration of multiple technologies and algorithms. For example, considerations involve how to obtain and process inflation data accurately and in real time, to design smart contracts for flatcoins to ensure their anti-inflation properties, and to ensure the scalability and efficiency of the system. Additionally, it is necessary to consider how to integrate with existing blockchain networks and other cryptocurrency projects to enable their widespread adoption.

7.Market Acceptance and User Education:

Market acceptance and user education are also crucial factors for the success of flatcoins. Designers and project parties need to consider how to educate users about the advantages and usage of flatcoins and how to promote their adoption to gain wider market acceptance.

The Significance of Flatcoins for the Crypto Market

The exploration of flatcoins has multi-faceted importance to the cryptocurrency market. These coins not only provide more choices for market participants, but also promote innovation and development within the cryptocurrency industry.

1. Protect purchasing power: Flatcoins protect users’ purchasing power by pegging to inflation indicators, which is extremely attractive to investors and users seeking to preserve asset value in a high-inflation environment. They provide the cryptocurrency market with a unique store of value and transaction tool.

2. Increase market stability and trust: Traditional stablecoins such as USDT and USDC are typically pegged to a specific fiat currency, but in an inflationary environment, their actual value decreases as the purchasing power of fiat currencies declines. However, flatcoins can help improve market stability and trust, and reduce inflation risks for investors and users.

3. Promote innovation in the cryptocurrency industry: The design and implementation of flatcoins requires solving many technical and economic issues, which can help drive innovation and development in the cryptocurrency industry. By solving the challenges faced by flatcoins, it can help the cryptocurrency market find new solutions and technologies, thereby driving progress throughout the industry.

4. Increase the utility and widespread acceptance of cryptocurrencies: Flatcoins can serve as a more reliable store of value and medium of exchange, increasing the utility and widespread acceptance of cryptocurrencies. They may attract more traditional financial market participants to the cryptocurrency market and may prompt more merchants and service providers to accept cryptocurrency payments.

5. Promote diversity in the cryptocurrency market: Flatcoins provide more choice and diversity to the cryptocurrency market, allowing market participants to choose different stablecoins based on their needs and risk appetite. This diversification can increase the complexity and maturity of the market, prompting more people to participate in the cryptocurrency market.

6. Provide new risk management tools for the global economy: In the context of increasing global economic uncertainty, flatcoins can serve as a new risk management tool to help individuals and businesses manage their assets and financial risks more effectively.

In summary, the exploration and development of flatcoins are of strategic significance to the cryptocurrency market. They can bring forth more opportunities to the market, while also presenting a series of challenges and issues that require collective exploration and resolution by market participants, developers and regulators.

Typical Project Analysis

1.Frax Price Index

Frax Price Index (FPI), one of the stablecoins of the Frax Finance ecosystem, is the first stablecoin pegged to a basket of consumer goods defined by the U.S. Consumer Price Index (CPI-U). Unlike traditional stablecoins denominated in national currencies, FPI creates an independent denominated unit that is fully backed and crypto collateralized, providing consumers with a unit of account separate from any nation state denominated money.

In terms of mechanisms to address inflation, FPI has the following innovations:

—Pegged to consumer goods: FPI is designed to peg its value to a basket of physical consumer goods defined by the U.S. CPI-U average. This peg is unique because it ties the value of digital assets to tangible consumer products, designed to preserve purchasing power and provide unprecedented price stability in volatile crypto markets.

—Track Inflation: The FPI mechanism utilizes the unadjusted 12-month inflation rate of the U.S. CPI-U reported by the federal government. This data is then submitted on-chain by a dedicated Chainlink oracle immediately upon public release. The reported inflation rate is applied to the redemption price of FPI stablecoins in the system contract. This pegged calculation rate is updated every 30 days and is synchronized with monthly CPI price data released by the U.S. government.

—Algorithmic Market Operations (AMOs): FPI adopts Algorithmic Market Operations (AMOs) similar to FRAX, the main stablecoin in the Frax Finance ecosystem. However, FPI’s model always maintains a 100% collateral ratio (CR), ensuring that the protocol’s balance sheet growth aligns at least with the CPI inflation rate. If AMO earnings fall below the CPI rate, the protocol will trigger specific actions to restore 100% CR, such as selling FPIS tokens in exchange for FRAX stablecoins.

—Stablecoin as unit of account: FPI aims to be the first on-chain stablecoin with an unit of account derived from a basket of commodities. FPI’s ambition goes beyond being an asset that protects against inflation; it seeks to create a new stablecoin to represent transactions, value, and debt. In doing so, it provides a framework to better measure whether real value added is actually fighting inflation and connects the on-chain economy with a basket of real assets.

—Governance and income distribution: FPIS token is introduced as the governance token of the system. It is entitled to seigniorage from the protocol and excess earnings will be transferred from the treasury to FPIS holders. When the FPI treasury does not create enough yield to maintain the increased backing per FPI due to inflation, new FPIS may be minted and sold to increase the treasury.

The management of FPI is enabled by the Frax Price Index Share (FPIS) token, which will be launched by Frax Finance in April 2022. FPIS is interconnected to the Frax Share (FXS) token thus it is referred to as a “linked governance token.” They jointly provide economic support and governance structure for FPI. FPIS supports the Frax ecosystem through its unique governance mechanism and revenue distribution structure, and provides unique governance and revenue opportunities to users of the FPI stablecoin.

FPI adjusts its system monthly via an on-chain Consumer Price Index to ensure an increase in its USD-denominated value for holders based on reported CPI growth each month. For example, if inflation is 9.1% in June 2022, FPIS will increase at 9.1% over the next 30 days.

According to the latest data from coingecko.com, the historical highest price of Frax Price Index Share (FPIS) is $14.20 (April 13, 2022), the historical lowest price was $0.67(June 10, 2022), and the price at the time of writing of this paper is $1.13(October 23, 2023).

2.Reserve Protocol

The Reserve project aims to create a decentralized stablecoin called Reserve Token (RSV), which allows holders to conduct various fiat-like transactions. It aims to reduce risk through diversification and decentralization, and create a stablecoin that can keep its value stable without inflation like traditional fiat currencies (such as the U.S. dollar), and not as volatile as cryptocurrencies such as Bitcoin.

The issuance and redemption mechanism of RToken

(Source: https://reserve.org/protocol/rtokens/)

In terms of mechanisms to address inflation, Reserve has the following innovations:

—Dual-token mechanism: Reserve adopts a dual token mechanism composed of RSV and Reserve Rights (RSR) tokens. As a stablecoin, RSV uses other assets and RSR to maintain its stability. This mechanism jointly supports the overall stability of the entire reserve network.

—Governance collateral mechanism: RSV is backed by a basket of assets. This collateral is crucial in maintaining the RSV’s peg and ensuring its stability against inflationary pressures. When the market value of the collateral token is insufficient to support the value of RSV, the protocol will use RSR to restore the peg.

Reserve’s design innovation revolves around creating a mechanism capable of withstanding inflationary market conditions, serving as a stable value store, and facilitating exchanges. Through a dual-token system, collateral backing, and a decentralized structure, RSV strives to provide a stablecoin solution that preserves purchasing power over the long term.

According to the latest data from coingecko.com, Reserve Rights (RSR) reached its historical highest price at $0.1174 (April 16, 2021), the lowest at $0.0012 (March 16, 2020), and was priced at $0.0019 at the time of reporting (October 23, 2023).

3.SPOT

SPOT is a stablecoin designed to be inflation-resistant and aims to fill the gap between speculative cryptocurrencies and U.S. dollar alternatives. SPOT is based on the Ampleforth and Buttonwood protocols and is governed by the FORTH token.

SPOT is defined as a perpetual note backed by fully collateralized AMPL derivatives. While it has many attributes of modern day stablecoins, it is not pegged to any specific value. It uses zero-liquidation tranching to provide stability, and the price may float in a range similar to AMPL. SPOT can be regarded as a derivative that reduces the volatility of AMPL supply.

By launching SPOT, the Ampleforth team hopes to provide the first truly decentralized unit of account for the cryptoeconomic system. As a decentralized stablecoin resistant to re-basing and inflation, SPOT aims to improve the overall distribution of the evolving digital financial system.

In terms of mechanisms to address inflation, SPOT has the following innovations:

— ERC-20 token and permanent wrapper: SPOT is an ERC-20 token and permanent wrapper that abstracts AMPL’s supply volatility from holders. Its price will be similar to AMPL (which targets the CPI adjusted 2019 dollar). The asset can function as both a refuge from volatility and a refuge from inflation. SPOT will be fully collateralized by AMPL-backed derivatives.

— SPOT Rotator: Through SPOT Rotator, staking AMPL can support SPOT Flatcoin, while maintaining AMPL rebase (a mechanism that uses liquidity to maintain purchasing power, and adjusts the total amount of AMPL by adjusting the amount of AMPL in the user’s wallet) and obtain AMPL benefits. SPOT is a decentralized flatcoin that uses tranching rather than liquidation markets to provide stability that scales.

SPOT Collateral Rotation Mechanism

(Source: docs.spot.cash/spot-documentation)

— Availability across multiple chains: Due to the cross-chain functionality of the SPOT protocol, SPOT is not confined to a single blockchain. It can be utilized and circulated on any cooperative chain (such as Ethereum, Polygon (PoS), Arbitrum, Optimism, BNB Chain, and Polygon zkEVM), leveraging the unique opportunities on each chain to provide users with more reliable assets.

Conclusion

If there were an inflation-proof stablecoin that could maintain its value for centuries without being impacted by inflation, it would be an extremely ideal asset. Imagine if you were able to earn some money today and leave it to your descendants so that when they use it a hundred years from now, they would be able to buy goods equivalent to what you could buy today — what a scenario it would be!

However, this is not something that fiat currencies, even strong ones like the US dollar, can achieve.

From a long-term perspective, in the field of cryptocurrency, especially in the stablecoin track, the progress of industry innovation is not only to expand existing asset classes, portfolios, and mechanisms, but also to create new products that can remain stable in the short term, and are more resilient and inflation-proof in the long term. Within this realm, flatcoins will definitely play a more important role.

About LK Venture:

LK Venture is a crypto investment and research institution under Linekong Interactive (08267.HK) that focuses on the Web3 field. It was formerly known as Consensus Lab. It focuses on investing in cutting-edge infrastructure, trading platforms, technology protocols and financial tools. Invest in more than 100 projects from North America, Asia, Europe and other countries and regions, including FTX, Polkadot, Filecoin, Casperlabs, and Coin98.

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