Can Investors Beat Inflation with Flatcoins?
Flatcoins, the latest addition to the cryptoasset industry, aim to address the age-old inflation problem by utilising decentralised technology. As we moved away from the gold standard, Bitcoin emerged as a digital currency, followed by stablecoins that offered faster transactions and greater efficiency.
However, unlike other stablecoins tied to the price of assets such as gold or the U.S. dollar, flatcoins are linked to the cost of living. Consequently, their value increases with the cost of living, so their purchasing power remains constant or "flat" over time. This unique characteristic makes flatcoins an attractive option for investors seeking a reliable store of value not subject to the volatility of traditional currencies or other assets.
In essence, flatcoins attempt to provide a stable and efficient means of storing value in uncertain economic conditions. However, flatcoins are not without risks. Although flatcoins may seem like a solution for those seeking stability against inflationary pressures, there is a considerable gap in regulatory oversight and other design issues, which we will explore below.
The Problem with Flatcoins
Although flatcoins are 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 (usually) digitised versions 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). 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.
This means there will never be a situation where flatcoins are more valuable than stablecoins because the existence of flatcoins hinges on the superiority of fiat currencies and stablecoins.
Today, there are several flatcoins available, such as TerraUSD (UST) stablecoin, which rely on algorithmic backing. However, the collapse of LUNA and UST is a cautionary example of the potential risks involved with this method.
Flatcoins Will Require DeFi Lending Protocols to Succeed
If flatcoins are to succeed, they are likely to require heavy involvement from other DeFi lending protocols.
For example, Frax, a stablecoin protocol, aims to create inflation-protected stablecoins by tracking a target standard of living using Chainlink on the Ethereum blockchain. With 5% annual inflation, Frax's smart contracts perform algorithmic trades to profit from the monthly inflation performance presented on Chainlink. To cover the inflation premium, Frax invests collateral in DeFi lending protocols like Aave and Convex, which enhance performance by allowing borrowers to access their tokens.
FPI (Frax Price Index) token miners can withdraw returns from these protocols. However, the FPI is "run" by a decentralised autonomous organisation (DAO), which could change its risk parameters in the future. Therefore, compared to simply owning a stablecoin and hedging with a gold exchange-traded fund (for example), the Frax mechanism is complicated and risky.
It is also worth noting that because DAOs control most DeFi protocols, there are other risks to consider. One significant risk is hacking smart contracts, which store increasingly large amounts of funding. Exploits here can lead to costly bugs and jeopardise the sustainability of a DAO. There have been many incidents where hackers have used smart contract flaws to liquidate decentralised applications in the past.
The Gap in Regulatory Oversight
Flatcoins are in a regulatory grey area. It hasn't been determined whether stablecoins are securities, even if they are not designed to appreciate. This raises more questions for flatcoins, which are designed to increase value. Major players, like USDT and USDC, will not get involved in flatcoins.
Flatcoins vs. Professional Portfolio Management
In conclusion, while flatcoins may be a viable solution for individuals seeking protection against inflation, the lack of regulatory clarity and oversight poses significant risks. If you already benefit from professional management of a diversified portfolio, regulated avenues to hedge against market uncertainties, inflation, and other risks are worth exploring. As we navigate the world of new cryptoassets, we must remain cautious not only of legal ambiguities but also to ensure we do not become unwitting participants in another "rug pull."
By partnering with licensed and knowledgeable professionals, we can navigate the uncertainties and mitigate risks associated with the emerging cryptoasset market.
Disclaimer: Kindly be aware that the information provided herein is intended solely for informational purposes and should not be construed as legal, tax, investment, financial, or any other professional advice.
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