Tuesday, 30 May 2023

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Flatcoiners should take a cue from TerraUSD’s fate

Flatcoiners should take a cue from TerraUSD's fate

The post-COVID-19 era has brought the issue of inflation to the forefront, leading to increasing interest within the Web3 space for creating flatcoins, a close “cousin” of stablecoins designed to mitigate inflation risk.

Many existing flatcoins, like Terra’s TerraUSD (UST) stablecoin, are algorithmically backed and therefore serve as a stark reminder of the risks associated with algorithmic backing, as demonstrated by the collapse of LUNA and UST. So, while the idea behind flatcoins may seem appealing, they raise significant reservations conceptually and in terms of design. Ultimately, the success of flatcoins will depend on whether developers can deliver on their promise.

To date, flatcoin white papers — including the one offered by Coinbase — do not appear to deliver on their envisioned promise, at least in their current state. In particular, the token economics designs of some projects are likely to pose an even higher risk than contemporary stablecoin designs.

Problems at the conceptual level

Examining the potential use cases of flatcoins is indeed crucial. While often presented as an asset that can help users preserve their purchasing power amid inflation and economic uncertainty, this idea could be misleading.

Stablecoins are digitized versions of fiat currencies, and their value as a medium of exchange and unit of account is the same as that of fiat currencies. In contrast, flatcoins are indexes of the buying power of a fiat currency obtained through oracles that collect data on economic indicators such as the Consumer Price Index (CPI).

Related: CBDCs will lead to absolute government control

As a result, the unit value of flatcoins will diverge from the fiat currency they track over time as long as inflation is not zero. Therefore, the existence of flatcoins depends on the assumption that fiat currencies or their digitized forms are the mediums of exchange and units of account.

In other words, there will not be a situation where flatcoins are better than stablecoins or fiat currencies as mediums of exchange and units of account because the existence of flatcoins hinges on the superiority of fiat currencies and stablecoins at these roles.

Inflation-pegged assets already exist

Flatcoins are financial instruments that expose investors to inflation rates, making them a derivative of inflation. Asset classes that expose investors to inflation risk have been around for a long time.

For instance, Treasury Inflation-Protected Securities (TIPS) have…

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