The time has come for an inflation-proof 'flatcoin'

Rather than create pegs to depreciating assets, coming up with a digital coin that is linked to the true rising cost of goods and services could transform the global economy

The collapse of the Terra/Luna tokens wiped billions off the market capitalisation of cryptocurrencies. Reuters

Stablecoins — particularly decentralised, algorithmic stablecoins — have come under heavy criticism since the dramatic demise of the UST stablecoin in May this year.

UST was issued by a protocol called Terra and its value was pegged to the US dollar via an algorithm that performed a supply/demand balancing act with the protocol's native token, Luna.

This mechanism was spectacularly successful for a period of time, with UST and Luna amassing more than $40 billion in market capitalisation between them.

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By early 2022, UST had become the third-largest stablecoin in circulation, behind USD Tether (USDT) and USD Coin (USDC). However, in May, the mechanism that held UST pegged to the dollar unravelled with terrifying speed.

On May 7, volatile market conditions and trading pressures caused investors to lose confidence in the Luna token, which began to sell off. UST promptly followed suit. Within the space of a few days, both cryptocurrencies collapsed, wiping out billions and heralding the onset of the current crypto winter.

Market concentration

For a hair-raising few weeks, the fallout affected stablecoins far and wide — from decentralised entity DAI to fiat-backed USDT and USDC.

However, five months later, USDT and USDC continue to dominate the stablecoin landscape, currently accounting for about $113bn in combined market capitalisation, or 12 per cent of the entire cryptocurrency market.

Although stablecoins have suffered an inevitable dip since the UST disaster, overall, their total circulation has remained remarkably stable, dipping from $170bn in January to about $148bn today. In short, stablecoins are here to stay.

This is reassuring for their users — many of whom have come to rely on them to deliver relatively low-risk income in a high-inflation environment.

However, what is less reassuring is that the vast majority of this stablecoin supply — a staggering 92 per cent — is held in three, centralised, fiat-backed coins: USDT, USDC and Binance USD (BUSD).

Regulatory risks

This market concentration presents a plethora of risks for any asset class. However, in the volatile and nascent world of cryptocurrencies, one additional risk for assets backed with fiat currencies is incoming regulation.

Following the collapse of UST, this risk has increased exponentially for centralised stablecoin issues such as Circle, Tether and Binance.

In direct response to the UST and Terra collapse, the US Congress announced in September a potential two-year ban on algorithmic stablecoins pegged to the US dollar.

During this period, they propose to investigate the asset class with a view to bringing in sweeping regulation for the listing of US stablecoins.

Meanwhile, regulators in the EU, the UK, Japan and other countries are working on rules and frameworks that could also completely change the stablecoin sector as we know it.

Inflationary pressures

However, perhaps the biggest worry for a stablecoin user today is that a staggering 98 per cent of stablecoins are pegged to the US dollar, the reserve currency of choice in the cryptocurrency ecosystem.

This type of innovation would be a first for any asset, either in the traditional or decentralised finance world, and could pave the way for a new generation of inflation protection and capital preservation.

Stefan Rust

While this is undoubtedly a more stable asset than volatile cryptocurrencies, its value is being rapidly eroded by rampant inflation.

Since 1972, the greenback has lost more than 80 per cent of its value. As the reported rate of inflation in the US edges ever closer to 10 per cent per annum, the purchasing power of the US dollar will continue to diminish over time.

In six years’ time, the average American’s standard of living could be 50 per cent lower than today if rampant inflation persists.

These figures demonstrate a burning need for an inflation-protected asset.

However, the current investment landscape simply doesn’t offer one that can achieve this. As inflation rises and central banks raise interest rates to cool an overheating market, we have seen both the traditional and cryptocurrency markets tumble.

A viable alternative

Yet, it is within our power to fix this. Rather than create pegs to depreciating assets as a way to build in an illusion of safety, it is time for a stablecoin that is linked to something other than the broken fiat monetary system.

The value of this new innovative stablecoin should be pegged to something much more real than the notional value of $1; it should be pegged to the true rising cost of goods and services.

Instead of “stable”, this coin should be “flat” — in that its purchasing power remains exactly the same throughout the holding period.

This type of innovation would be a first for any asset, either in the traditional or decentralised finance world, and could pave the way for a new generation of inflation protection and capital preservation.

This flatcoin could viably transform the global economy as we know it.

Stefan Rust is the founder of Laguna Labs, a blockchain development house, and former chief executive of bitcoin.com