Produced by: CGV Research
Author: Shigeru
TL;DR
Rise of Inflation-resistant Stablecoins: Digital stablecoins pegged to fiat currencies are impacted by declining purchasing power, leading the financial markets to show strong interest in “Flatcoin,” a stablecoin designed to maintain purchasing power in inflationary environments. This new type of stablecoin hedges against inflation by pegging its value to a specific basket of goods, and is considered a significant direction for the future of finance by industry leaders such as Vitalik Buterin and Coinbase’s CEO Brian Armstrong.
Definition of Inflation-resistant Stablecoins: Unlike stablecoins pegged to specific assets or fiat currencies, inflation-resistant stablecoins are designed to combat inflation and aim to preserve purchasing power. In countries with soaring inflation rates, it provides an effective tool to counter inflation and is used as a hedge in high inflation regions like Latin America and Africa.
Design Challenges of Inflation-resistant Stablecoins: Accurately measuring inflation rates poses a challenge due to differences in countries, regions, and measurement methods like CPI and PPI. It requires reliance on reliable, accurate data sources and ensuring data validation and auditing. High system stability and security are needed to combat manipulation, attacks, and market volatility. Legal and regulatory differences across countries may impose additional restrictions and risks on stablecoin design and issuance. Effective economic models are needed to ensure the stablecoin accurately reflects inflation. Technically, real-time processing of inflation data, designing stable smart contracts, and ensuring system efficiency are essential. Market acceptance and user education are also key to success.
Significance of Inflation-resistant Stablecoins in the Cryptocurrency Market: They protect purchasing power for users in high inflation environments, providing more reliability compared to traditional stablecoins. They drive technological innovation, increase the practicality of digital currencies, attract more traditional financial participants, and contribute to the formation of a clear regulatory environment. Additionally, they bring diverse options to the market and offer new risk management tools for the global economy.
Analysis of Typical Projects: This includes the Frax Price Index (FPI) and the stablecoin linked to CPI-U from Frax Finance, which is fully collateralized by crypto assets. The Reserve project aims to create a decentralized stablecoin, Reserve Token (RSV), by diversifying risk. SPOT, based on Ampleforth and Buttonwood, aims to bridge the gap between speculative cryptocurrencies and dollar alternatives, providing stability through zero-clearing layering and can operate on multiple chains.
Why Do We Need Inflation-resistant Stablecoins (Flatcoin)?
As a reflection of economic and national power, currencies have undergone many changes throughout history. Whenever a dominant power gradually declines and is replaced by emerging powers, the status of its dominant currency also changes accordingly.
The Dutch guilder dominated during its economic peak, and the British pound of the British Empire became the globally trusted currency. However, none of these currencies were able to permanently maintain their leading position.
Recently, Ray Dalio, the founder of Bridgewater Associates, suggested that the status of the US dollar as the world’s reserve currency may be challenged. In an interview in 2023, he emphasized that as the influence of the US dollar diminishes globally, the international economic and monetary landscape is becoming multipolar, and the reserve currency status of the dollar faces future uncertainty.
Since January 2020, the average purchasing power of Americans has decreased by 23.90%.(Data source: https://truflation.com/)
Over the three-year period from October 10, 2020, to October 10, 2023, Truflation data reveals that the average purchasing power of Americans has decreased by 20.39%. This effectively means that for someone holding entirely USD-denominated assets, their ability to buy goods in the market has shrunk by one-fifth during these three years.
However, this inflation phenomenon is not unique to the United States. Data from the International Monetary Fund (IMF) projects a global inflation rate of 6.6% in 2023, compared to 8.8% in 2022. The World Economic Forum further points out that due to complex factors such as deglobalization, climate change, the wage-price spiral, and highly liquid global markets, the global economy is facing a sustained period of high inflation.
Certain countries, like Argentina, Turkey, and Iran, have shown extremely high inflation rates of 76.1%, 51.2%, and 40.0% respectively in 2023 due to political instability, international sanctions, monetary policy missteps, and economic management issues.
In the field of digital currencies, while traditional stablecoins are designed to be pegged to specific fiat currencies or assets to maintain their stability, they are also affected by fiat currency inflation. From the first batch of stablecoins born in 2014, to the widespread attention gained in 2017 with the rise of decentralized finance (DeFi), Tether (USDT) and USD Coin (USDC) have become the third and fourth largest cryptocurrencies in global market capitalization respectively. Currently, there are approximately 200 stablecoins in the market with a total market capitalization of 190 billion USD.
However, stablecoins like USDT and USDC primarily operate in a centralized manner, carrying the risk of being subject to control by central entities and potential exposure to counterparty and regulatory risks.
Even more crucially, as global inflation continues to rise, the real value of these stablecoins pegged to fiat currencies like the US dollar is being eroded.
Comparison of the Relative Purchasing Power of the US Dollar (Compared to Initial Issuance) (Data source: howmuch.net)
In light of this, stablecoins aren’t necessarily truly “stable.” This may seem counterintuitive, but it’s a real dilemma. With the rise in inflation rates and global economic uncertainty, the financial markets, especially in the realm of crypto finance, are beginning to seek a new type of stablecoin that can maintain purchasing power even in an inflationary environment. Enter the “inflation-resistant stablecoin” (also known as Flatcoin), which has become a new focal point in the market.
Flatcoin, as a decentralized stablecoin, emerged with the aim of safeguarding assets from the impact of inflation. Unlike traditional stablecoins, Flatcoin combats inflation by maintaining its peg to the prices of specific baskets of goods, thereby preserving purchasing power. Since the conception of Flatcoin, it has garnered significant attention from the crypto industry. The explicit goal of Flatcoin is to “maintain stable purchasing power while also possessing some flexibility to withstand economic uncertainties caused by the traditional financial system.”
At the end of 2022, Ethereum co-founder Vitalik Buterin, in an interview with Bankless, shared his outlook on the cryptocurrency industry in 2023, mentioning three “massive” opportunities yet to be 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 hyperinflation of the US dollar, would provide a tremendous opportunity for the entire cryptocurrency industry. He emphasizes that providing a reliable, inflation-resistant stablecoin for billions of users would be a significant supplement to the traditional financial system.
Coinbase CEO Brian Armstrong has also mentioned Flatcoin multiple times in public interviews and discussed this new technology on Twitter, ranking it as the top among ten crypto technologies. Brian believes that Flatcoin represents the future direction of stablecoins. Unlike traditional stablecoins pegged to fiat currencies, Flatcoin offers a new and more stable value storage by tracking inflation. He also emphasizes that while Coinbase has not yet developed in this area, they have a strong interest in the potential of this new type of stablecoin.
What is an Inflation-Resistant Stablecoin?
Inflation-resistant stablecoins, often referred to as “Flatcoins” (or alternatively as “value-stablecoins” or “purchasing-power-stablecoins”), are a type of stablecoin designed to track inflation rates rather than a specific currency.
The concept of “Flatcoin” was initially introduced by former Coinbase CTO Balaji Srinivasan in 2021. The purpose of Flatcoin is to maintain stable purchasing power, even in an inflationary environment, by pegging to the Consumer Price Index (CPI) or other inflation indicators. These stablecoins are able to maintain their real value, providing users with a more stable and reliable means of storing value.
Subsequently, blockchain technology development company Laguna Labs introduced a new cryptocurrency called Nuon. They claim it to be the world’s first over-collateralized and decentralized “Flatcoin.”
Just as decentralized protocols are the answer to the risks posed by centralized currencies, over-collateralization is the answer to maintaining value in times of market collapse, and inflation-resistant stablecoins offer a solution for preserving value over time.
With rising inflation rates, such as the United States’ inflation rate reaching 8.5% in 2022, far above the Federal Reserve’s 2% inflation target, inflation-resistant stablecoins have become an attractive option. They are typically not subject to the limitations of bank deposits and often offer higher interest rates, making them an enticing choice in the face of inflation.
In Latin America, where the inflation rate reached 14.6% in 2022, and is projected to reach 9.5% in 2023, these high inflation countries are using inflation-resistant stablecoins as a hedge against high inflation and as a means to facilitate cross-border remittances across different regions.
Distinguishing Inflation-Resistant Stablecoins from Other Stablecoins
Different types of stablecoins can primarily be classified based on their backing assets or operational mechanisms. Here are the main types of stablecoins, along with their characteristics and examples:
1. Commodity-backed Stablecoins:
- Typically backed by hard assets like gold or real estate to maintain the stablecoin’s value. For example, PAX Gold (PAXG) is a stablecoin pegged to gold, with each PAXG representing one ounce of gold.
2. Crypto-backed Stablecoins:
- Typically maintain the stablecoin’s value by over-collateralizing with crypto assets. For example, DAI is a crypto-backed stablecoin issued by MakerDAO, with its value pegged to the US dollar but maintained by collateralizing with assets like Ethereum.
3. Fiat-backed Stablecoins:
- Usually pegged to a specific fiat currency like the US dollar, euro, or Chinese yuan in a 1:1 ratio. For example, USDT (Tether) and USDC (USD Coin) are stablecoins pegged to the US dollar in a 1:1 ratio.
4. Algorithmic Stablecoins:
- Typically adjust the supply through algorithms to maintain the stablecoin’s value. For example, Ampleforth (AMPL) is an algorithmic stablecoin whose supply dynamically adjusts based on market demand.
The main purpose of inflation-resistant stablecoins (such as Flatcoin) is to protect purchasing power by pegging them to inflation indices like the Consumer Price Index (CPI) and thus, mitigating the impact of inflation. In contrast, other types of stablecoins typically maintain their value through pegging to specific assets or employing algorithms.
In the design and implementation of inflation-resistant stablecoins, more complex economic models and algorithms may be required to accurately reflect inflation changes and adjust the stablecoin’s value accordingly. Additionally, these stablecoins may face more intricate regulatory challenges, particularly regarding requirements related to the accuracy and fairness of inflation data.
Design Challenges of Inflation-Resistant Stablecoins:
1. Accurate Measurement of Inflation Rates:
Accurately measuring inflation rates is a crucial factor influencing the design of inflation-resistant stablecoins. The inflation rate may vary from country to country, necessitating designers to find an accurate and reliable method for measurement. Inflation can be measured through various means, such as the Consumer Price Index (CPI), Producer Price Index (PPI), or other inflation indicators. However, these indicators may be influenced by various factors, including political considerations, differing economic policies, and variations in statistical methods, potentially affecting the accuracy and effectiveness of inflation-resistant stablecoins. For instance, in a use case of the Volt Protocol, its corresponding local stablecoin VOLT maintains stability by anchoring it to the Consumer Price Index (CPI). If the inflation rate remains at 7% for a year, the token will be anchored at $1.07.
2. Reliability of Data Sources:
The design of inflation-resistant stablecoins relies on reliable and accurate data sources. If the data sources are inaccurate or unreliable, it may lead to a disconnect between the stablecoin’s value and the actual inflation rate, thus compromising its inflation-resistant properties. Designers need to identify dependable data providers and ensure the accuracy and timeliness of the data. Additionally, robust data validation and auditing mechanisms need to be established to ensure the authenticity and completeness of the data.
3. System Stability and Security:
Any cryptocurrency project, especially stablecoin projects, needs to consider the stability and security of the system. The design of inflation-resistant stablecoins requires contemplation on how to prevent manipulation, attacks, and other factors that might affect the stability and security of the system. Furthermore, it is necessary to contemplate how to design robust protocols and mechanisms to respond to market fluctuations and unforeseen events, ensuring the continuous 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 US dollar due to a lack of collateral. This case illustrates how algorithmic stablecoins can be vulnerable to speculative attacks when the system lacks adequate collateral.
4. Legal and Regulatory Challenges:
Inflation-resistant stablecoins may be subject to the legal and regulatory environments of different countries and regions. These legal and regulatory aspects may affect the design, issuance, and trading of inflation-resistant stablecoins. Some countries may restrict or prohibit the use of these stablecoins, or require projects to comply with specific regulatory requirements. These legal and regulatory challenges may add complexity and risk to the project. Towards the end of 2019, when stablecoins were just beginning to emerge, the G7 summit strongly declared them as a serious risk for international settlements. This demonstrates the influence of legal and regulatory environments on the design and application of stablecoins. In September 2023, the G20 summit approved the Financial Stability Board’s recommendations on the regulation, supervision, and oversight of crypto asset activities and markets, as well as global stablecoin arrangements. It is expected that more related regulatory requirements will be introduced in due course.
5. Design of Economic Models:
The economic model of inflation-resistant stablecoins forms the foundation for ensuring their functionality and effectiveness. Designers need to contemplate how to construct an effective economic model to ensure that the stablecoin’s value accurately reflects the inflation rate. This may encompass determining the issuance, circulation, and burning mechanisms of the stablecoin, as well as adjusting its value through market mechanisms.
6. Complexity of Technical Implementation:
The technical implementation of inflation-resistant stablecoins is a complex process, necessitating consideration of various technologies and algorithms. For example, how to accurately and in real-time acquire and process inflation data, how to design the smart contracts of the stablecoin to ensure its inflation-resistant properties, and how to ensure the scalability and efficiency of the system. Additionally, it is necessary to contemplate how to integrate with existing blockchain networks and other cryptocurrency projects to achieve widespread application of inflation-resistant stablecoins.
7. Market Acceptance and User Education:
Market acceptance and user education are also critical factors for the success of inflation-resistant stablecoins. Designers and project teams need to consider how to educate users about the advantages and usage of inflation-resistant stablecoins, as well as how to promote their adoption for broader market acceptance.
Significance of Inflation-Resistant Stablecoins for the Cryptocurrency Market:
Exploring and developing inflation-resistant stablecoins holds multifaceted strategic importance for the cryptocurrency market. They not only provide more options for market participants but also drive innovation and development within the cryptocurrency industry.
1. Protection of Purchasing Power:
Inflation-resistant stablecoins protect users’ purchasing power by pegging them to inflation indices. This is highly attractive for investors and users seeking asset preservation in high inflation environments. They provide a unique value storage and trading tool for the cryptocurrency market.
2. Increased Market Stability and Trust:
Traditional stablecoins (such as USDT and USDC) are typically pegged to specific fiat currencies. However, in an inflationary environment, their actual value decreases along with the purchasing power of the fiat currency. By providing an inflation-resistant stablecoin, market stability and trust can be increased, reducing inflation risks for investors and users.
3. Driving Innovation in the Cryptocurrency Industry:
The design and implementation of inflation-resistant stablecoins require addressing many technical and economic challenges, which contributes to driving innovation and development within the cryptocurrency industry. Addressing the challenges faced by inflation-resistant stablecoins can help the cryptocurrency market find new solutions and technologies, thereby advancing the entire industry.
4. Enhancing Practicality and Widespread Acceptance of Cryptocurrencies:
Inflation-resistant stablecoins can serve as a more reliable value storage and medium of exchange, enhancing the practicality and widespread acceptance of cryptocurrencies. They may attract more participants from traditional financial markets into the cryptocurrency market and potentially encourage more merchants and service providers to accept cryptocurrency payments.
5. Promote Diversification of the Cryptocurrency Market. Inflation-resistant stablecoins provide the cryptocurrency market with more choices and diversity, allowing market participants to select different stablecoins based on their needs and risk preferences. This diversity can increase the complexity and maturity of the market, encouraging more people to participate in the cryptocurrency market.
6. Provide New Risk Management Tools for the Global Economy. Against the backdrop of increased global economic uncertainty, inflation-resistant stablecoins can serve as a new risk management tool, helping individuals and businesses more effectively manage their assets and financial risks.
In summary, the exploration and development of inflation-resistant stablecoins hold significant strategic importance for the cryptocurrency market. They can bring more opportunities to the market, but also present a range of challenges and issues that need to be collectively explored and addressed by market participants, developers, and regulatory authorities.
Analysis of Typical Projects:
1. Frax Price Index (FPI):
The Frax Price Index (FPI) is one of the stablecoins in the Frax Finance ecosystem. It is the first stablecoin pegged to a basket of tangible consumer goods defined by the US Consumer Price Index (CPI-U). Unlike traditional stablecoins priced in national currencies, the FPI creates an independent unit of account fully backed by cryptocurrency collateral, providing consumers with a unit unrelated to any national currency.
Regarding mechanisms for addressing inflation, the FPI introduces the following innovations:
- Pegged to Consumer Goods: The design of FPI aims to anchor its value to a basket of tangible consumer goods defined by the average of the US CPI-U. This peg is unique as it ties the value of digital assets to tangible consumer goods, with the goal of preserving purchasing power and offering a level of price stability unprecedented in the volatile cryptocurrency market.
- Inflation Tracking: The FPI mechanism uses the unadjusted 12-month inflation rate reported by the US federal government’s CPI-U. This data is then promptly submitted to the chain by a dedicated Chainlink oracle upon public release. The reported inflation rate is applied to the redemption price of the FPI stablecoin in the protocol’s contracts. This peg calculation rate is updated every 30 days in sync with the monthly CPI price data published by the US government.
- Algorithmic Market Operations (AMOs): The FPI adopts similar Algorithmic Market Operations (AMOs) as the primary stablecoin FRAX in the Frax Finance ecosystem. However, the FPI’s model maintains a constant 100% collateral ratio (CR), ensuring that the growth of the protocol’s balance sheet aligns at least with the CPI inflation rate. If AMO earnings fall below the CPI rate, the protocol triggers specific operations to restore a 100% CR, such as selling FPIS tokens in exchange for FRAX stablecoins.
- Stablecoin as the Unit of Account: The goal of FPI is to become the first on-chain stablecoin with a derived unit of account from a basket of goods. This aspiration is not only about becoming an inflation-resistant asset; it seeks to create a new stablecoin to represent transactions, value, and debt. In doing so, it provides a framework to better measure if real appreciation is indeed counteracting inflation and links the on-chain economy with a basket of tangible assets.
- Governance and Revenue Distribution: The FPIS token is introduced as the governance token of the system. It has the right to minting fees from the protocol, and excess revenue is transferred from the treasury to FPIS holders. In cases where FPI financial revenue is insufficient to support the increased FPI backing due to inflation, new FPIS tokens may be minted and sold to bolster the treasury.
The management of FPI is achieved through the Frax Price Index Share (FPIS) token, which was introduced by Frax Finance in April 2022. FPIS is intricately linked with the Frax Share (FXS) token, jointly providing economic support and governance structure for FPI. Through its unique governance mechanism and revenue distribution structure, FPIS offers support to the Frax ecosystem and provides unique governance and revenue opportunities for users of the FPI stablecoin.
FPI adjusts the system monthly based on the on-chain Consumer Price Index to ensure that holders of FPI see an increase in its USD-denominated value every month based on the reported CPI growth. For example, if the inflation rate was 9.1% in June 2022, FPIS would increase at a rate of 9.1% over the following 30 days.
2. Reserve Protocol
The Reserve Protocol aims to create a decentralized stablecoin called Reserve Token (RSV). It allows holders to engage in various transactions similar to fiat currencies. The goal is to mitigate risks through diversification and decentralization, while establishing a stablecoin that maintains its value, unlike traditional fiat currencies (such as the US dollar) that experience inflation, but without the high volatility seen in cryptocurrencies like Bitcoin.
Diagram of RToken’s Issuance and Redemption Mechanism (Data source: https://reserve.org/protocol/rtokens/)
In terms of addressing inflation, Reserve incorporates the following innovations:
Dual Token Mechanism: Reserve employs a dual token mechanism consisting of Reserve Token (RSV) and Reserve Rights Token (RSR). RSV, as the stablecoin, is maintained in stability using a combination of other assets and RSR. This mechanism collectively supports the overall stability of the Reserve network.
Governance Collateral Mechanism: RSV is collateralized by a basket of assets. This collateralization is crucial in maintaining the peg of RSV and ensuring its stability against inflationary pressures. When the market value of collateral tokens is insufficient to support the value of RSV, the protocol utilizes RSR to restore the peg.
Reserve’s design innovations revolve around creating a mechanism capable of withstanding the impacts of inflationary market conditions, providing a stable value store, and facilitating exchanges. Through a dual-token system, collateral support, and a decentralized structure, RSV strives to offer a stablecoin solution that preserves purchasing power over the long term.
3. SPOT
SPOT is a stablecoin designed to hedge against inflation, aiming to bridge the gap between speculative cryptocurrencies and dollar alternatives. Built on the Ampleforth and Buttonwood protocols, it is governed by the FORTH token.
SPOT is defined as a perpetuity note backed by fully collateralized AMPL derivatives. While it shares many attributes of modern stablecoins, it is not pegged to any specific value. It employs a zero-liquidation tranching mechanism to provide stability, with prices potentially fluctuating within a range similar to AMPL. SPOT can be seen as a derivative that mitigates AMPL supply volatility.
By introducing SPOT, the Ampleforth team hopes to offer the crypto-economic system its first truly decentralized unit of account. As a decentralized stablecoin immune to rebase and inflation, SPOT aims to enhance the overall distribution of the evolving digital financial system.
In terms of mechanisms to address inflation, SPOT introduces the following innovations:
ERC-20 Token and Perpetual Wrapper: SPOT functions as an ERC-20 token and a perpetual wrapper, abstracting away supply volatility of AMPL from holders. Its price will behave similarly to AMPL (which targets adjustment to the 2019 USD CPI), serving as a safe haven against volatility and inflation. SPOT will be fully collateralized by derivatives supported by AMPL.
SPOT Rotator: By pledging AMPL through the SPOT Rotator, users can support the SPOT Flatcoin while maintaining AMPL rebase and earning AMPL rewards. SPOT is a decentralized Flatcoin utilizing a layering market instead of liquidation, enabling scalable stability.
Diagram of SPOT Collateral Rotation Mechanism (Data source: docs.spot.cash/spot-documentation)
Multi-Chain Availability: Due to the full-chain capabilities of the SPOT protocol, SPOT is not confined to a single blockchain. It can be used and traded on any compatible chain, such as Ethereum, Polygon (PoS), Arbitrum, Optimism, BNB Chain, and Polygon zkEVM. This allows for the maximization of unique opportunities on each chain, providing users with more reliable assets.
Conclusion
If there were an anti-inflation stablecoin capable of preserving its value across centuries, impervious to the erosion of inflation, it would be an exceptionally ideal asset. Imagine if you could earn some funds today and pass them on to your descendants, and a hundred years from now, they could use those funds to purchase goods equivalent to what you can buy today. What a scenario that would be!
However, this is not something traditional currencies, even strong ones like the US Dollar, can achieve. In the long-term perspective of the cryptocurrency space, especially in the realm of stablecoins, industry innovation should not only expand existing asset categories, portfolios, and mechanisms, but it should also create new types of assets that remain stable in the short term, are more robust in the long term, and can withstand inflation. In this regard, anti-inflation stablecoins are bound to play a more crucial role.
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About Cryptogram Venture (CGV):
CGV (Cryptogram Venture) is a crypto investment institution headquartered in Tokyo, Japan. Since 2017, its fund and predecessor funds have participated in investing in over 200 projects, including the incubation of the licensed Japanese yen stablecoin JPYW. CGV is also a limited partner in several globally renowned crypto funds. Since 2022, CGV has successfully hosted two editions of the Japan Web3 Hackathon (TWSH), supported by Japan's Ministry of Education, Culture, Sports, Science and Technology, Keio University, NTT Docomo, and other institutions and experts. CGV has branches in Hong Kong, Singapore, New York, Toronto, and other locations. Additionally, CGV is a founding member of the Bitcoin Tokyo Club.
Disclaimer:
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