Overview of Anti-Inflation Stablecoin Track: Why is it Considered by Vitalik as One of the Top 3 Crypto Trends in 2023?
If there were an anti-inflation stablecoin that could maintain its value against the erosion of inflation over centuries, it would be an extremely ideal asset.Author: Leo Deng, LK Venture
TL; DR
- The Rise of Inflation-Resistant Stablecoins: Digital stablecoins pegged to fiat currencies are affected by declining purchasing power, leading to strong interest in a "Flatcoin" that can maintain purchasing power stability in inflationary environments. This new type of stablecoin is linked to the prices of a specific basket of goods to resist inflation, viewed by industry leaders like Vitalik Buterin and Coinbase CEO Brian Armstrong as an important direction for the future of finance.
- Definition of Inflation-Resistant Stablecoins: Unlike other stablecoins pegged to specific assets or fiat currencies, inflation-resistant stablecoins are designed to combat inflation and aim to maintain purchasing power. In countries with soaring inflation rates, they provide an effective tool against inflation and are used as a hedging strategy in high-inflation regions such as Latin America and Africa.
- Design Challenges of Inflation-Resistant Stablecoins: Accurate measurement of inflation rates becomes challenging due to differences in countries, regions, and measurement methods such as CPI and PPI; reliance on reliable and accurate data sources is necessary, along with ensuring data verification and auditing; high system stability and security are required 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 must be designed to ensure stablecoins accurately reflect inflation; technically, real-time processing of inflation data, designing stable smart contracts, and ensuring system efficiency are required; 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, provide stability, and are more trustworthy compared to traditional stablecoins; they drive technological innovation, enhance the practicality of digital currencies, attract more traditional financial participants, and contribute to the formation of a clear regulatory environment. At the same time, they bring diversified choices to the market and provide new risk management tools for the global economy.
- Analysis of Typical Projects: Including Frax Price Index (FPI), a stablecoin from Frax Finance pegged to CPI-U, fully crypto-collateralized; the Reserve project, aimed at creating a decentralized stablecoin Reserve Token (RSV) to reduce risk through diversification; SPOT, based on Ampleforth and Buttonwood, aims to bridge the gap between speculative cryptocurrencies and dollar alternatives, providing stability through zero liquidation tranching and operating across multiple chains.
Why Do We Need Inflation-Resistant Stablecoins (Flatcoins)?
As a reflection of economic and national power, currency has undergone many changes throughout history. Whenever a dominant power gradually declines and is replaced by an emerging power, the currency it dominates also changes accordingly.
The Dutch guilder once dominated during its economic peak, and the British pound became the world's trusted currency during the British Empire. However, none of these currencies managed to maintain their leading position permanently.
Recently, Ray Dalio, founder of Bridgewater Associates, suggested that the dollar's status as the world's reserve currency may be challenged. In a 2023 interview, he emphasized that as the dollar's influence globally diminishes, the international economic and monetary landscape is becoming multipolar, leading to uncertainty about the dollar's future as a reserve currency.
*Since January 2020, the average purchasing power of Americans has decreased by 23.90% (Data from: * https://truflation.com/).
From October 10, 2020, to October 10, 2023, Truflation data shows that the average purchasing power of Americans has decreased by 20.39%. This effectively means that for those holding dollar-denominated assets, their purchasing power in the market has shrunk by one-fifth over these three years.
However, this inflation phenomenon is not unique to the United States. The International Monetary Fund (IMF) projects a global inflation rate of 6.6% in 2023, down from 8.8% in 2022. The World Economic Forum further points out that due to complex factors such as de-globalization, climate change, wage-price spirals, and high liquidity in global markets, the world economy is facing a phase of persistently high inflation.
Some countries, such as Argentina, Turkey, and Iran, are experiencing 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 digital currency space, while traditional stablecoins aim to maintain their stability by pegging to specific fiat currencies or assets, they are also affected by fiat currency inflation. From the first batch of stablecoins born in 2014 to the widespread attention gained with the rise of decentralized finance (DeFi) in 2017, Tether (USDT) and USDCoin (USDC) have become the third and fourth largest cryptocurrencies by market capitalization, respectively. Currently, there are about 200 stablecoins in the market, with a total market cap of $190 billion.
However, these stablecoins like USDT and USDC primarily operate in a centralized manner, carrying risks of central entity control, which may expose holders to counterparty and censorship risks.
More critically, as global inflation continues to rise, the real value of these stablecoins pegged to fiat currencies like the dollar is suffering erosion.
Comparison of dollar purchasing power relative indicators (compared to the initial issuance) (Data from: howmuch.net)
Thus, stablecoins are not necessarily "stable," which seems unreasonable but is a real predicament. With rising inflation rates and global economic uncertainty, financial markets, especially in the crypto finance sector, are beginning to seek a new type of stablecoin that can maintain purchasing power stability even in inflationary environments. Inflation-resistant stablecoins (also known as Flatcoins) have emerged as a new focus in the market.
Flatcoins, as a decentralized stablecoin, aim to protect assets from inflation. Unlike traditional stablecoins, Flatcoins resist inflation by maintaining a peg to the prices of a specific basket of goods, thereby protecting purchasing power. Since the concept of Flatcoins was proposed, it has attracted significant attention from the crypto industry. The clear goal of Flatcoins is to "maintain stable purchasing power while also possessing certain elasticity to resist economic uncertainties caused by the traditional financial system."
At the end of 2022, Vitalik Buterin, co-founder of Ethereum, shared his outlook on the cryptocurrency industry in a Bankless interview, mentioning three "huge" opportunities that have 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 that can resist various conditions (including hyperinflation of the dollar) would provide a tremendous opportunity for the entire cryptocurrency industry. He emphasized that providing a reliable, inflation-resistant stablecoin for billions of users would be an important complement to the traditional financial system.
Coinbase CEO Brian Armstrong has also mentioned Flatcoins multiple times in public interviews and discussed this new technology on Twitter, listing it as the top of ten crypto technologies.
Brian believes that Flatcoins represent the evolutionary direction of future stablecoins. Unlike traditional stablecoins pegged to fiat currencies, Flatcoins provide a new and more stable way to store value by tracking inflation. He also emphasized that while Coinbase has not yet developed in this area, they have shown strong interest in the potential of this new type of stablecoin.
What Are Inflation-Resistant Stablecoins?
Inflation-resistant stablecoins, commonly referred to as "Flatcoins" (also known as "value-stable coins" or "purchasing power-stable coins"), are stablecoins designed to track inflation rates rather than specific currencies.
The term "Flatcoin" was first proposed by Balaji Srinivasan, former CTO of Coinbase, in 2021. The purpose of Flatcoins is to maintain stable purchasing power, even in inflationary environments. By linking to the Consumer Price Index (CPI) or other inflation indicators, these stablecoins can maintain their real value, providing users with a more stable and reliable way to store value.
Subsequently, blockchain technology development company Laguna Labs launched a new cryptocurrency called Nuon, claiming 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 during market crashes, and inflation-resistant stablecoins are the solution for maintaining value over time.
As inflation rates rise, for example, the inflation rate in the U.S. reached 8.5% in 2022, far exceeding the Federal Reserve's target of 2%, 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 appealing choice in the face of inflation.
In Latin America, inflation rates reached 14.6% in 2022, with an expected 9.5% in 2023. In these high-inflation countries, using inflation-resistant stablecoins can serve as a hedge against high inflation and facilitate cross-border remittances into and across different countries.
Differences Between Inflation-Resistant Stablecoins and Other Stablecoins
Different types of stablecoins can be classified based on their backing assets or operational mechanisms. Here are the main types of stablecoins along with their characteristics and examples:
Commodity-Backed Stablecoins: Typically backed by hard assets such as gold or real estate to maintain the value of the stablecoin. For example, PAX Gold (PAX G) is a stablecoin pegged to gold, with each PAX G representing one ounce of gold.
Crypto-Backed Stablecoins: Typically maintain the value of the stablecoin through over-collateralization of crypto assets. For example, DAI is a crypto-collateralized stablecoin issued by MakerDAO, pegged to the dollar but maintained through collateralization of Ethereum and other crypto assets.
Fiat-Backed Stablecoins: Typically pegged to a fiat currency at a 1:1 ratio, such as the dollar, euro, or yuan. For example, USD T (Tether) and USD C (USD Coin) are stablecoins pegged to the dollar at a 1:1 ratio.
Algorithmic Stablecoins: Typically adjust supply through algorithms to maintain the value of the stablecoin. For example, Ampleforth (AMPL) is an algorithmic stablecoin whose supply dynamically adjusts based on market demand.
The primary purpose of inflation-resistant stablecoins (like Flatcoins) is to protect purchasing power by linking to inflation indices (such as CPI) to avoid the effects of inflation. In contrast, other types of stablecoins typically maintain their value stability through pegging to specific assets or through algorithms.
In terms of design and implementation, inflation-resistant stablecoins may require more complex economic models and algorithms to accurately reflect changes in inflation and adjust the value of the stablecoin accordingly. Additionally, inflation-resistant stablecoins may face more complex regulatory challenges, particularly concerning the accuracy and fairness of inflation data.
Design Challenges of Inflation-Resistant Stablecoins
Designing inflation-resistant stablecoins is a technically and economically challenging task, aiming to maintain the purchasing power of the stablecoin in an inflationary environment. However, there are several challenges in designing the mechanisms for inflation-resistant stablecoins:
Accurate Measurement of Inflation Rates: Inflation rates are a key factor affecting the design of inflation-resistant stablecoins. Inflation rates may differ across countries and regions, requiring designers to find an accurate and reliable method to measure inflation. 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 factors, economic policies, and differences in statistical methods, which can affect the accuracy and effectiveness of inflation-resistant stablecoins.
For example, in a case study of the Volt Protocol, its corresponding local stablecoin VOLT maintains stability by anchoring to the Consumer Price Index (CPI). If the inflation rate for a year remains at 7%, the token will be anchored at $1.07.
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 value of the stablecoin and the actual inflation rate, thereby losing its inflation-resistant characteristics. Designers need to find reliable data providers and ensure the accuracy and timeliness of the data. Additionally, robust data verification and auditing mechanisms need to be established to ensure the authenticity and completeness of the data.
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 must consider how to prevent manipulation, attacks, and other factors that may affect system stability and security. Furthermore, robust protocols and mechanisms must be designed to cope with market volatility and unforeseen events, ensuring the continuous stable operation of the system.
For example, on May 10, 2022, the price of the algorithmic stablecoin Terra USD, running on the Terra blockchain, fell and lost its peg to one dollar. This case illustrates how algorithmic stablecoins can be easily affected by speculative attacks when the system lacks collateral.
Legal and Regulatory Challenges: Inflation-resistant stablecoins may be influenced by the legal and regulatory environments of different countries and regions. These laws and regulations may affect the design, issuance, and trading of inflation-resistant stablecoins. Some countries may restrict or prohibit the use of inflation-resistant stablecoins or require project parties to comply with specific regulatory requirements. These legal and regulatory challenges may increase the complexity and risks of the project.
At the end of 2019, when stablecoins were just beginning to emerge, the G7 summit strongly stated the serious risks of using them for international settlements. This highlights 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 on the regulation, supervision, and oversight of "crypto asset activities and markets and global stablecoin arrangements," with more related regulatory requirements expected to be introduced.
Design of Economic Models: The economic model of inflation-resistant stablecoins is the foundation for ensuring their functionality and effectiveness. Designers need to consider how to construct an effective economic model to ensure that the value of the stablecoin accurately reflects inflation rates. This may include determining the issuance mechanism, circulation mechanism, and destruction mechanism of the stablecoin, as well as how to adjust the value of the stablecoin through market mechanisms.
Complexity of Technical Implementation: The technical implementation of inflation-resistant stablecoins is a complex process that requires consideration of various technologies and algorithms. For example, how to accurately and in real-time obtain and process inflation data, how to design the smart contracts of the stablecoin to ensure its inflation-resistant characteristics, and how to ensure the scalability and efficiency of the system. Additionally, consideration must be given to how to integrate with existing blockchain networks and other cryptocurrency projects to achieve widespread adoption of inflation-resistant stablecoins.
Market Acceptance and User Education: Market acceptance and user education are also key factors for the success of inflation-resistant stablecoins. Designers and project parties need to consider how to educate users about the advantages and usage of inflation-resistant stablecoins and how to promote them for broader market acceptance.
Significance of Inflation-Resistant Stablecoins for the Cryptocurrency Market
Exploring inflation-resistant stablecoins has multiple important implications for the cryptocurrency market. They not only provide more choices for market participants but also drive innovation and development in the cryptocurrency industry.
Protecting Purchasing Power: Inflation-resistant stablecoins protect users' purchasing power by linking to inflation indicators, which is highly attractive for investors and users seeking to preserve their assets in high-inflation environments. They provide a unique value storage and trading tool for the cryptocurrency market.
Increasing Market Stability and Trust: Traditional stablecoins (like USDT and USDC) are typically pegged to specific fiat currencies, but in inflationary environments, their real value declines as the purchasing power of fiat currencies decreases. By providing an inflation-resistant stablecoin, market stability and trust can be increased, reducing inflation risks for investors and users.
Driving Innovation in the Cryptocurrency Industry: The design and implementation of inflation-resistant stablecoins require solving many technical and economic problems, which helps drive innovation and development in the cryptocurrency industry. By addressing the challenges faced by inflation-resistant stablecoins, the cryptocurrency market can find new solutions and technologies, thereby advancing the entire industry.
Enhancing the Practicality and 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 space and encourage more merchants and service providers to accept cryptocurrency payments.
Promoting Diversity in the Cryptocurrency Market: Inflation-resistant stablecoins provide more choices and diversity in the cryptocurrency market, 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.
Providing New Risk Management Tools for the Global Economy: In the context of increasing global economic uncertainty, inflation-resistant stablecoins can serve as a new risk management tool, helping individuals and businesses manage their assets and financial risks more effectively.
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 while also presenting a series of challenges and issues that require collaboration among market participants, developers, and regulatory agencies to explore and resolve.
Analysis of Typical Projects
1. Frax Price Index
Frax Price Index (FPI) is one of the stablecoins in the Frax Finance ecosystem, and it is the first stablecoin pegged to a basket of physical consumer goods defined by the U.S. Consumer Price Index (CPI-U). Unlike traditional stablecoins priced in national currencies, FPI creates an independent pricing unit fully backed by cryptocurrency collateral, providing consumers with a unit unrelated to any national currency.
In terms of mechanisms addressing inflation, FPI has the following innovations:
--- --- Linking to Consumer Goods: The design of FPI aims to anchor its value to a basket of physical consumer goods defined by the average value of the U.S. CPI-U. This linkage is unique as it connects the value of digital assets to tangible consumer goods, aiming to maintain purchasing power and provide price stability unheard of in the volatile crypto market.
--- --- Inflation Tracking: The FPI mechanism uses the unadjusted 12-month inflation rate reported by the U.S. federal government for CPI-U. This data is then submitted on-chain immediately after public release by a dedicated Chainlink oracle. The reported inflation rate is applied to the redemption price of FPI stablecoins in the system's contracts. This pegging calculation updates every 30 days, synchronized with the monthly CPI price data released by the U.S. government.
--- --- Algorithmic Market Operations (AMOs): FPI adopts algorithmic market operations (AMOs) similar to the main stablecoin FRAX in the Frax Finance ecosystem. However, FPI's model always maintains a 100% collateralization ratio (CR), ensuring that the protocol's balance sheet grows at least in line with the CPI inflation rate. If AMO yields fall below the CPI rate, the protocol will trigger specific operations to restore the 100% CR, such as selling FPI S tokens in exchange for FRAX stablecoins.
--- --- Stablecoin as an Account Unit: FPI aims to be the first on-chain stablecoin with an account unit derived from a basket of goods. This ambition is not just to become an asset that resists inflation; it seeks to create a new stablecoin to represent transactions, value, and debt. By doing so, it provides a framework to better measure whether actual value appreciation is effectively combating inflation and connects the on-chain economy with a basket of physical assets.
--- --- Governance and Revenue Distribution: FPI S tokens are introduced as the governance token of the system. They are entitled to receive minting taxes from the protocol, and excess revenue will be transferred from the treasury to FPI S holders. When FPI's fiscal revenues are insufficient to maintain the increased FPI support due to inflation, new FPI S tokens may be minted and sold to bolster the treasury.
The governance of FPI is implemented through Frax Price Index Share (FPI S) tokens, which were launched by Frax Finance in April 2022. FPI S is linked to Frax Share (FXS) tokens, providing economic support and governance structure for FPI. FPI S supports the Frax ecosystem through its unique governance mechanism and revenue distribution structure, offering 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 FPI holders increase their dollar-valued worth according to the reported CPI increase each month. For example, if the inflation rate in June 2022 is 9.1%, FPI S will grow at a rate of 9.1% in the following 30 days.
2. Reserve Protocol
The Reserve project aims to create a decentralized stablecoin called Reserve Token (RSV), allowing holders to conduct various fiat-like transactions, designed to reduce risk through diversification and decentralization, and create a stablecoin that maintains its value without the inflationary pressures of traditional fiat currencies (like the dollar) while not being as volatile as cryptocurrencies like Bitcoin.
*Illustration of the issuance and redemption mechanism of RToken (Data from: * https://reserve.org/protocol/rtokens/).
In terms of mechanisms addressing inflation, Reserve has the following innovations:
--- --- Dual Token Mechanism: Reserve employs a dual-token mechanism consisting of RSV and Reserve Rights Token (RSR). While RSV serves as the stablecoin, it also uses other assets and RSR to maintain the stability of RSV. This mechanism collectively supports the overall stability of the Reserve network.
--- --- Governance Collateral Mechanism: RSV is backed by a basket of assets as collateral. This collateral is crucial for maintaining the peg of RSV and ensuring its stability against inflationary pressures. When the market value of the collateral tokens is insufficient to support the value of RSV, the protocol uses RSR to restore the peg.
The design innovations of Reserve revolve around creating a mechanism capable of withstanding the impacts of inflationary market conditions while providing stable value storage and exchange functionality. Through a dual-token system, collateral support, and decentralized structure, RSV strives to offer a stablecoin solution that can preserve purchasing power over the long term.
3. SPOT
SPOT is a stablecoin designed to resist inflation, aiming to fill the gap between speculative cryptocurrencies and dollar alternatives. SPOT is based on the Ampleforth and Buttonwood protocols and governed by the FORTH token.
SPOT is defined as a perpetual note supported by fully collateralized AMPL derivatives. While it possesses many attributes of modern stablecoins, it is not pegged to any specific value. It uses zero liquidation tranching to provide stability, and its price may fluctuate within a range similar to AMPL, making SPOT a derivative that reduces the supply volatility of AMPL.
By launching SPOT, the Ampleforth team aims to provide the first truly decentralized unit of account for the crypto economy. As a decentralized stablecoin that is not subject to rebase and resists inflation, SPOT aims to improve the overall distribution of the evolving digital financial system.
In terms of mechanisms addressing inflation, SPOT has the following innovations:
--- --- ERC-20 Token and Permanent Wrapper: SPOT is an ERC-20 token and a permanent wrapper that abstracts the supply volatility of AMPL from holders. Its price will be similar to AMPL (targeting adjustment to the 2019 dollar CPI), serving as a haven against volatility and inflation. SPOT will be fully collateralized by AMPL-backed derivatives.
--- --- SPOT Rotator: Through the SPOT Rotator, staking AMPL can support SPOT Flatcoin while maintaining AMPL rebase (a mechanism to preserve purchasing power by adjusting the number of AMPL in users' wallets to adjust the total supply of AMPL) and earning AMPL yields. SPOT is a decentralized Flatcoin that uses tranching rather than liquidation markets to achieve scalable stability.
Illustration of the SPOT Collateral Rotation mechanism (Data: docs.spot.cash/spot-documentation)
--- --- Multi-Chain Availability: Due to the full-chain functionality of the SPOT protocol, SPOT is not limited to one blockchain and can be used and liquidated across any cooperating chains (such as Ethereum, Polygon (PoS), Arbitrum, Optimism, BNB Chain, and Polygon zkEVM), fully leveraging unique opportunities on each chain to provide users with more reliable assets.
Conclusion
If there were an inflation-resistant stablecoin that could maintain its value against inflation over centuries, it would be an ideal asset. Imagine if you could earn some money today and leave it for your descendants, allowing them to purchase goods equivalent to what you can buy today in a hundred years. What a scenario that would be!
However, this is not something fiat currencies can achieve, even strong currencies like the dollar.
From a long-term perspective, the progress of innovation in the cryptocurrency space, especially in the stablecoin sector, should not only expand existing asset classes, combinations, and mechanisms but also create new types of assets that maintain stability in the short term and are more robust in the long term, capable of resisting inflation. In this context, inflation-resistant stablecoins will undoubtedly play a more important role.
