Flatcoins: Inflation-Adjusted Stablecoins

Inflation-adjusted stablecoin ( Flatcoin ) is an emerging token economics concept designed to serve as a means of value storage that can adjust its value according to inflation changes. The goal of Flatcoin is to maintain the purchasing power of token holders or specific groups ( such as platform users ).

Taking the fictional "i-DAI" as an example, which is DAI excluding inflation factors. i-DAI will anchor to a reference point in time and adjust its price in real-time according to inflation changes to maintain the purchasing power of holders. Although i-DAI is currently just a concept, it can be realized through the controller-based stablecoin (CBS), with actual cases such as RAI already in existence.

Definition of Inflation

In economics, inflation refers to the general rise in prices that leads to a decrease in the purchasing power of money. In the web3 space, inflation is often used to describe the impact of token supply growth, more accurately referred to as "dilution." This article adopts the traditional definition of inflation.

In an inflationary environment, currency holders may experience a decline in purchasing power, weakening trust in the currency and the economic system. Therefore, inflation is a key indicator of the economic system, and central banks around the world are committed to keeping the annual inflation rate of fiat currency at a low level, typically 2%-4%. However, this is not an easy task, as the current global economy shows.

Flatcoin Design Challenges

Flatcoin design faces several challenges that need to be addressed, among which the most critical is accurately perceiving inflation and creating appropriate incentive mechanisms.

Inflation, like many concepts in economics, operates within complex adaptive systems. This means that the dynamic interactions of numerous factors and variables, including unpredictable human behavior, can influence the causes and consequences of inflation. This presents challenges for the design of Flatcoin, requiring consideration of multiple factors, including:

1. Low time granularity of inflation index
2. The difficulty of adjusting time and space when measuring with sensors
3. The complexity of sensor fusion and effective controller design
4. The challenge of achieving economic changes in Flatcoin through appropriate incentive mechanisms.

Controller-Based Semi-Stablecoin: A Feasible Flatcoin Design

A promising approach to building a Flatcoin is to draw on the ideas and technologies of currently successful stablecoins. These stablecoins adopt the concept of a controller to "sense" price changes and adjust participant incentive mechanisms to make the token value tend to track the reference value.

This type of controller-based stablecoin is called Controller-Based Stablecoins (CBS), RAI is a practical application case. One of the reasons RAI adopts a controller is that the historical behavior of central banks controlling inflation can be well described by a PID controller. The theoretical study by Hawkings et al. in 2014 and the empirical research by Shepherd et al. in 2019 have both proven this.

RAI Case Study

RAI is a controller-based stablecoin that uses an unsupervised PI controller to guide economic incentives and a real-time oracle that perceives the RAI/USD price, keeping its value aligned with the USD.

Users can use ETH as collateral to obtain over-collateralized loans denominated in RAI. The outstanding debt is denominated in RAI, and the interest rate ( and redemption rate ) are defined by the PI controller. The available loan amount is determined by the redemption price, which is usually closely related to the market price of RAI, with a difference of about 1%.

The interest rate adjustment is based on the difference between the RAI market price and the redemption price. When the redemption price is higher than the market price, the interest rate tends to rise; conversely, it tends to fall or even be negative (.

The reason why the price of RAI is relatively stable is due to its counter-cyclical incentive mechanism. The market price is determined by the secondary market and fluctuates significantly, while the redemption price is determined by the PI controller and is more stable. When there is a large discrepancy between the two, rational users have an arbitrage motive.

The advantage of the RAI controller is that all incentives guided by the controller are driven by external benchmarks, specifically the RAI/USD price obtained through oracles. RAI can achieve price stability without directly relying on USD reserves or liquidity pools.

For designing Flatcoins, RAI represents the starting point for building an MVP, which requires two elements:

1. inflation oracle 2( The moderately adjusted controller is used to measure inflation.

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Distributed Control Challenges

Building a Flatcoin requires a moderately adjustable controller and an inflation oracle, both of which face challenges.

Due to the spatial, temporal, and compositional properties involved in inflation, comprehensively measuring inflation is a fundamental challenge in the design of distributed control systems.

From the perspective of control theory, the design challenges of Flatcoin can be understood as:

1. There is a widely distributed "controlled object", namely the goods and services market, which sends price signals for different goods at different times and places.

2. Design sensors to collect relevant signals and merge them at appropriate spatial and temporal scales.

3. Signal input controller, processing to create a sufficiently rich world model to estimate the market intervention required by the system, allowing the value of Flatcoin to evolve as expected.

4. The system requires executors to provide incentives to drive the secondary market to adjust the value of Flatcoin, aligning it with inflation.

Control Theory in Complex Adaptive Systems

In control theory, it is essential to clearly define the "boundaries" or environment of the system. A model can be established to adequately understand the world within the boundaries, allowing for controllable decisions to be made within the system. The components of a control system include:

• Plants) Controlled Object(: A controlled physical or mathematical system.
• Sensors): Devices that measure a system's behavior or certain aspects of the environment.
• Actuators (: Devices that influence the future behavior of the system.
• Controllers) controllers(: The brain of the control system, processing sensor information and adjusting actuator behavior.

Sensors, actuators, and controllers form the basic building blocks of a control system, which can be used to regulate and automate various processes, even in systems with unpredictable human interactions.

In-Depth Analysis of Flatcoin Challenge

Any token that tracks the inflation rate to mitigate its impact on purchasing power must answer the questions of which "sensors" and information sources are used, such as "Where does inflation occur?" "Who is affected?" "Which goods and services are impacted?"

Inflation is not a singular phenomenon. Although there are inflation indices such as the GDP deflator, CPI, and PPI, there are significant differences among these indicators as well as in geographical locations and industries. Moreover, these indices have a low temporal granularity, mostly updated monthly, while changes in purchasing power can immediately affect daily life.

Designing Flatcoin must carefully consider its intended scope and coverage. Tokens adjusted for inflation rates may face very high price volatility, as certain regions or industries may experience prolonged high inflation, while others may have low volatility or no inflation.

Choosing an inflation measure is also challenging, as inflation can vary significantly at the national, regional, or metropolitan level. Standardized inflation measures like the CPI do not account for differences in purchasing power among different occupations, investments, and socio-economic or demographic groups.

From an implementation perspective, accurately and timely measuring inflation increases design complexity, as this type of token is susceptible to potential manipulation. The executors of the Flatcoin system will rely on the reliability of the oracle subsystem, making their design no easy task.

The next step in promoting the implementation of Flatcoin

It is recommended to adopt a concept validation with minimal functionality ) PoC ( design and pilot implementation to achieve the initial design goals. The PoC can have upgrade capabilities, gradually addressing more specific and prioritized design challenges in iterations.

One starting point is to first limit the spatial component of inflation. The recommended simple PoC design starts with a regional index Flatcoin and a scalar price index within a single currency market, but this simple design may face various arbitrage challenges.

In the long run, global composite index inflation tokens will be able to address these arbitrage issues, with more robust use cases, but they require more conceptualization and design to tackle the various challenges presented in this article. With the deployment and evaluation of the first PoC, additional requirements and feasibility can be proposed, gradually advancing the research and development of sensors, controllers, and actuators to achieve a truly effective global-scale Flatcoin, covering diversified, multi-space indices.

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