Are Flatcoins Better Than Stablecoins?
What Are Flatcoins, Why We Need Them, and the Way Forward — Featuring ISC, Nuon, and Others.
Stablecoins have emerged as pivotal applications with a market capitalization exceeding $140 billion, proving useful for a variety of activities ranging from decentralized finance (DeFi) to payments. They have become the cornerstone of DeFi, yet they depreciate at the same rate as the US dollar, a peculiar situation for an industry in pursuit of superior forms of alternative currency. Stablecoins encounter the same issues as their fiat analogs to which they are pegged — they are subject to inflation.
As the Financial Times highlights, the cryptocurrency movement originated as a response to the potential devaluation of fiat currencies due to inflation. Nevertheless, the most practical application of crypto, stablecoins, essentially serves as digital equivalents of fiat currencies, inheriting similar shortcomings, including the risk of devaluation.
Flatcoins offer a remedy, being softly pegged to inflation. They represent a middle ground between the excessive volatility of Bitcoin and the excessive stability of stablecoins.
Before delving into fiat currencies, it’s crucial to understand stablecoins, which have become the go-to option for crypto users seeking to escape the volatility inherent in most digital assets. Stablecoins are cryptocurrencies pegged to the value of a real-world asset, typically the US dollar, to maintain price stability. This attribute makes them suitable for transactions and preserving value without significant price fluctuations. However, stablecoins are not immune to inflation. As the purchasing power of the underlying asset (e.g., the US dollar) erodes over time, the value stored in stablecoins also depreciates proportionally.
The Inflation Problem:
- Fiat Currencies Depreciate Due to Inflation
The purchasing power of the US dollar has diminished over time, meaning it now takes more dollars to purchase the same amount of goods and services than it did in 2004. This decrease in value is attributable to inflation.
Fiat currencies, such as the US dollar, are not backed by a physical commodity like gold. Instead, their value is based on the faith and credit of the government that issues them. As a result, fiat currencies can be susceptible to inflation if the government prints too much money. When there is more money in circulation, each unit of currency becomes worth less.
Consider the example of the US Big Mac Index. The Big Mac Index indicates that the price of a Big Mac in the US has increased significantly over the past 20 years, while the purchasing power of the US dollar has decreased. This is a consequence of inflation.
2. BTC as a Speculative Asset
BTC is the oldest cryptocurrency to date. Bitcoin has recently been on a rally, touching $64,000. Imagine having paid for a pizza with 10,000 BTC in 2010, worth roughly $40 at the time, compared to its current valuation of over $640 million!
This volatility also presents a problem for everyday use. Imagine the uncertainty associated with buying a cup of coffee if the price of Bitcoin could fluctuate significantly between the time you place the order and pay for it. This volatility hinders the widespread adoption of Bitcoin as a medium of exchange.
2. Gold hasn’t been a strong hedge
Gold is often touted as a safe haven and inflation hedge, but its performance as a hedge has been inconsistent. The arguments against gold as a strong hedge are its inconsistency in inflationary periods, recent performance, long-term horizon, and additional costs for secure storage and insurance.
The Problem with Existing Stablecoins
- The Majority of Stablecoins are Centralized and Fiat-Backed
USDC and USDT are the leading stablecoins, dominating the market with a combined supply exceeding $100 billion, alongside a limited number of decentralized stablecoins like DAI. This concentration raises concerns about centralization and the asset management practices of these organizations.
A notable incident occurred in March 2023 when USDC lost its peg during the Silicon Valley Bank crisis.
2. 99% is dependent on the USD
Holders of USD-backed stablecoins are at risk of facing economic consequences such as inflation, economic slowdown, or policy changes in the US. This is because the value of the stablecoin is directly linked to the USD.
As USD-backed stablecoins dominate the crypto market, they limit diversification. This amplifies risks and hinders their ability to serve as a true hedge against traditional financial systems.
3. A very small portion of stablecoins is decentralized and is an over-collateralized stablecoin
Operating on blockchains provides greater transparency into the reserves that back stablecoins and the mechanisms governing their issuance and management. This aims to reduce reliance on trusted third parties and offers a more decentralized and over-collateralized stablecoin. However, it’s important to note that only a very small portion of stablecoins is currently decentralized and over-collateralized.
Unlike fiat-backed stablecoins, these are backed by cryptocurrency assets deposited as collateral. The value of this collateral exceeds the value of the issued stablecoins, creating a buffer against potential price fluctuations in the underlying assets. However, they expose users to smart-contract risks in the event of unforeseen circumstances.
The next generation of stablecoins is going to go beyond just stablecoins. Rather, a variety of flatcoins and CBDCs will emerge to cater to various use cases.
Flatcoins — The Origins
The idea of a flat coin has been around for a few years, which became popular after Balaji mentioned that in 2021. This became popular more recently when Brian Armstrong, the founder of Coinbase mentioned it in his top ideas to watch out for.
Apart from being inflationary, stablecoins carry the following risks:
- A greater risk of a run than bank deposits, as stablecoins do not have access to central banks as lenders of last resort or to deposit insurance — a scenario already observed with USDC’s depegging last year.
- A lack of transparency regarding the assets backing them. For example, USDT offers very little transparency about its reserves.
- Regulatory risks — being directly pegged to a currency, they are susceptible to bans by regulators.
This has led to the emergence of the innovative concept of Flatcoins — which are not subject to depreciation due to inflation, nor to the impending regulation that will affect centralized stablecoins in the US and many other countries.
How Flatcoins work?
Flatcoin is essentially a digital-native currency, backed by hard assets and financial instruments (or Real World Assets) with low volatility. This makes it a viable store of value and a global means of payment that offers a positive return, as opposed to the 0% or, in fact, negative real return when considering inflation.
Blockchains like Solana facilitate transactions at unprecedented speeds and enable self-custody of the underlying assets transparently. This also promotes financial inclusion, as flatcoins can be accessible in regions with unstable monetary systems — a key reason why USDT is dominant in emerging markets like LATAM, where currencies are often unstable.
Currently, a few flatcoins are already operational:
- International Stable Currency (ISC) — This flatcoin is pegged to the value of a basket of real-world assets that excludes the U.S. dollar.
- Nuon — Claimed to be the first true flatcoin, it operates through an Ethereum smart contract. Nuon utilizes Truflation’s Chainlink oracles to assess the daily inflation levels.
- Spot — A project by the Ampleforth Foundation, designed to be pegged to the cost of living in the United States.
- Frax Price Index — Rather than creating a stablecoin, they use the FRAX price as collateral, linking it to the CPI-U average or the monthly-released BLS numbers. However, this involves significant costs for them to rebase and issue FPIS tokens to FRAX holders every month to adjust for inflation.
- Flat Money — called UNIT, a decentralized money designed to outpace inflation and dampen crypto volatility, built on Base.
The way flatcoin works is:
- Collateralization: Similar to some stablecoins, flatcoins are backed by real-world assets or other cryptocurrencies deposited as collateral.
- Investment Strategies: The collateral is then invested in various decentralized finance (DeFi) protocols, such as lending platforms.
- Yield Generation: The returns generated from these investments are used to adjust the total supply of flatcoins.
Basket of Assets
Flatcoins typically rely on a basket of assets, utilizing either a publicly available cost-of-living index, such as the Consumer Price Index (CPI), or a proprietary cost-of-living index (like Truflation, developed by the Nuon team), to calculate the flatcoin’s value daily according to the index and adjust the token supply accordingly.
A simpler method involves using a basket of Real World Assets (RWA) to collateralize a flatcoin, effectively replicating the index. RWAs are, essentially, off-chain financial assets that can be tokenized on-chain. The selection of these assets is crucial, with the following factors playing a pivotal role:
- Asset Selection — The assets included must accurately represent the cost of living to ensure the flatcoin’s value remains stable.
- Asset Liquidity — Essential for maintaining stability, as it facilitates quick redemption. For example, Real Estate is considered a poor choice due to its illiquidity — as seen when USDR, a stablecoin backed by Real Estate, depegged due to a lack of liquid assets.
- Asset Risk — Selecting assets that are low-risk and have low volatility is crucial to ensure stability and prevent significant depreciation.
- Transparency — Critical for building trust among holders and ensuring that all flatcoins are adequately backed by assets.
Case in Point: ISC’s Basket of Assets
Taking the example of ISC, it targets an asset weightage of 20% each for:
- Equity: Global
- Commodity: Gold
- Bonds: Global Bonds
- Bonds: Short-term Treasuries
- Cash
ISC has further decentralized its reserves, with each ISC interfacing with the Real World Asset Market to buy and sell the assets needed to maintain the ISC Reserve Basket for each ISC in circulation. The assets acquired by the ISC Reserves are utilized to uphold the ISC Target Price, providing continuous liquidity for ISC.
How has Flatcoins like ISC performed?
Backtesting of ISC from 1999 to 2023 demonstrates that the purchasing power of ISC’s underlying basket of assets outperforms that of top fiat currencies. The price of ISC steadily increased over time as the reserve grew from the returns generated by the ISC Reserves, whereas the US Dollar experienced a substantial loss, with its purchasing power dwindling by almost half.
Can Flatcoins Win Over Stablecoins?
The journey for flatcoins to surpass stablecoins is indeed an uphill battle. The key to success lies in the Go-To-Market strategy and early mover advantage. For instance, despite USDT’s lack of transparency compared to USDC, it leads the market by almost 4x! This is primarily due to the Lindy effect and its aggressive early integrations. Being one of the first stablecoins, Tether secured its dominance as most trading pairs are denominated in USDT rather than USDC.
The stablecoin space is witnessing the entry of new players like Ethena and various LST-backed designs such as MarginFi’s YBX, Gravita, Curvance, Prisma, and Gyroscope. However, their usage is currently confined to the DeFi sector, where they serve as a base asset for additional leverage.
Flatcoins have the potential to initially excel in DeFi by offering boosted APYs and providing investors with exposure to RWA. Moreover, with the narrative surrounding Ondo’s USDY and its RWA focus, flatcoins could leverage similar narratives to gain traction. An alternative strategy could involve concentrating more on payments and fintech rather than DeFi. However, this approach is more long-term and will require significant efforts in awareness and education to achieve widespread adoption.
To gain momentum, flatcoins will need to pursue aggressive business development and integration strategies, including:
- Listing on centralized exchanges, initially targeting smaller and crypto-native ones like Cube or Backpack.
- Functioning as on/off-ramps by securing critical partnerships and providing source fiat liquidity, which can then be merged with on-chain liquidity.
- Engaging in DeFi integrations, such as forming pools, a strategy already pursued by ISC with platforms like Solend and Meteora.
- Connecting with on-chain treasuries of DAOs and projects.
- Establishing fintech partnerships, especially in emerging markets.
The emerging popularity of yield-bearing stablecoins, such as Ethena’s USDe and Ondo Finance’s USDY, indicates market approval. Flatcoins could similarly captivate the market as yield-accruing stablecoins, leveraging the excitement surrounding new launches or token incentives.
Industry Response and the Future of Flatcoins:
The crypto industry’s reception of flatcoins is mixed:
- Advocates: Major entities like Coinbase recognize flatcoins’ potential and are exploring integration into their ecosystems.
- Skeptics: Some parties, including traditional financial institutions and certain crypto traders, remain wary due to flatcoins’ inherent complexities, counterparty risks, and regulatory ambiguities.
Closing Thoughts: Flatcoins as Stablecoins v2
While flatcoins are unlikely to dethrone stablecoins in the near future, they present a compelling vision for the evolution of currency. Rather than relying on the dollarization of economies, emerging markets could turn to flatcoins, which offer protection against extreme risks and promote financial inclusion. In essence, flatcoins represent a progressive step forward in the realm of digital currencies.
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Disclaimer: This essay is meant for educational purposes only and has no intension to promote or advice to trade digital currencies. NFA DYOR!
