I'll start with the conclusion. I don't think flatcoins are a good idea.
The idea for flatcoins has been around for a while, but it got a wider airing when it popped up in a Coinbase marketing piece from earlier this year. Now, arch-crypto hater Nouriel Roubini has undergone a Damascene conversion and is about to introduce a crypto flatcoin, suggesting that these novel instruments are "the way forward."
What is a flatcoin?
If you own one dollar's worth of stablecoins or one dollar's worth of Wells Fargo deposits, both stay locked at $1 dollar indefinitely. A flatcoin, by contrast, slowly rises in value over time to compensate the holder for inflation. So if you own a single flatcoin worth $1 today, it will be worth $1.0001 tomorrow, and $1.0002 the next day, and so on. Twelve months later its value will have arrived at $1.05. This 5% appreciation protects you from 5% inflation, leaving your purchasing power unchanged.
Roubini and Coinbase are marketing flatcoins as a blockchain-specific thing, but there's no reason the concept couldn't by packaged up as a traditional financial product, one without a blockchain. Imagine a Wells Fargo account that holds 100 in Wells flatbalances which rise by 3-4% a year. Or imagine a flatnote, the issuer indexing the purchasing power of its paper banknotes to inflation by promising to buy them back at progressively higher prices.
Roubini stakes out a role for flatcoins as a potential "global means of payment." As far as monetary/payments technology goes, I disagree. I think flatcoins are an evolutionary dead-end.
One of the key features of money that makes it so popular is that it is directly fused to the dominant commercial language that we all use in our day-to-day economic lives.
What do I mean when I say commercial language? We converse and haggle with each other in terms of the dollar, we think and plan in terms of dollars, we dream in dollars, and we remember in dollars. Every facet of our day-to-day commercial lives revolves around this very basic measuring unit. (In Europe, the euro serves as the basis of Europe's commercial language, and in Japan it's the yen.)
The dollars that we own in our pockets (and in our bank accounts, as well as the stablecoins in our Metamask wallets) have been conveniently designed to be fully compatible with the dollar measuring unit that we refer to in language. That is, our media of exchange are pegged, or wed, to $1. For instance, if I've got to make a $1500 rent payment next week, I know that the 1500 units sitting in my bank checking account are a precise fit for meeting that obligation. I don't know the same about my other assets, say my S&P 500 ETF, my gold, my government bonds, or my dogecoins.
This standardization is a convenient feature. It takes a lot of hassle out of day-to-day commercial life. It means that when we buy things or make plans to buy things, it's not necessary to engage in constant translations between the dollar media in our pocket and the dollars in our speech and thoughts and plans. As Larry White once put it, harmonizing the unit we use in our speech with the units we transact with "economizes on the information necessary for the buyer's and the seller's economic calculation."
Since everyone tends to converge on these very useful standardized units for making payments (i.e. deposits, stablecoins, and banknotes), the markets for them have become highly developed and liquid. This only makes them more useful for payments, in effect locking in their dominance.
A flatcoin, by contrast, has been rendered incompatible with the dollars that we use in our speech. One unit might be worth 1.1145 times the dollars we use in our speech today, and 1.1147 tomorrow, and 1.1205 next month. This erases one of the most user-friendly features of money, its concordance with the commercial vernacular, alienating anyone who might use it for their day-to-day spending. Flatcoins will thus be less liquid than standardized 1:1 dollars, and this lack of liquidity will render them even less useful for making payments.
There's the secondary problem with flatcoins that stems from taxes. Since a flatcoin rises in value over time, all purchases made with flatcoins will generate a small taxable capital gain. This introduces an administrative burden which makes it even less likely that people will use flatcoins as an everyday medium of exchange.
This incongruity between linguistic dollars and flatcoins doesn't mean that people won't hold them. They might be useful as a type of long-term savings vehicle, much like how one might buy and hold a fixed income ETF. But unlike Nouriel Roubini, I don't think they are "the way forward" when it comes to acting as a medium of exchange. No one is going to be buying a coffee with a flatcoin.
great article, but gotta disagree here. The linguistics issue you raise is totally valid, but can be solved with creative token designs. Essentially, a flatcoin is just a loyalty program for the US dollar. Its a savings account return on a debit card product. A zero duration TIPS. The key in the design that enables its use as a medium of exchange is to separate the underlying token from the inflation offsets/rewards so that the price of the underlying doesn't fluctuate. We can use erc6551s or token bound account for this. Regarding the "taxable event" issue, coinbase is calling the yield "rewards" or "points" to side-step that. Not sure if it will work, but maybe. Plus, even if an inflation offsets on the dollar was taxable, its still better than just simply letting your dollar depreciate. Yeah, you might have to pay taxes on any yield, but at least you're still getting something, right? I think we'll see a time where consumer will have a choice: (1) a dollar that depreciates and rewards me with nothing, OR (2) a flatcoin dollar that rewards with points when inflation rises. I think both consumers and merchants will chose the later. Even for coffee :-)
ReplyDelete‘Regarding the "taxable event" issue, coinbase is calling the yield "rewards" or "points" to side-step that.’
DeleteYou have to admit that’s a bridge too far. Credit card companies (like your employer) let consumers side-step income taxes on credit card rewards because they structure those rewards as discounts/rebates (e.g. spend $4,000 -> get $750 worth of Points).
What’s the financial/legal engineering analogue that lets flatcoin holders side-step capital gains taxes?
USDC rewards are taxable. Coinbase itself specifies this:
Delete"US customers that are subject to US tax reporting are required to report their earnings from USDC Rewards. US customers who earn more than $600 in USDC rewards will receive a 1099-MISC from Coinbase. You can learn more about the 1099-MISC on the IRS official website."
https://help.coinbase.com/en/coinbase/coinbase-staking/rewards/usd-coin-rewards-faq
"The key in the design that enables its use as a medium of exchange is to separate the underlying token from the inflation offsets/rewards"
I don't really get this. So an owner of a flatcoin can spend on the fixed $1 component of the flatcoin and keep the bit that appreciates? If so, doesn't that create fungibility issues? You've got a bunch of flatcoins circulating whole, you've got some that are just $1 tickets, and then you've got a population of small stubs that rise in value.
totally, so regarding the "taxable event" issue, sure, it might be a bridge too far to simple call the "rewards" and be done with it. So, JP your point that Coinbase will send a 1099 only if you earn more than $600 in rewards is super helpful here. That's our threshold. So, at say, 5% Rewards, an individual would have to hold roughly $12k in tokens to cross the $600 mark and trigger a 1099. My guess is that most consumers probably won't hold that much in flatcoins, at least, not at the beginning as the tokens roll out. So, for many consumers, the taxes may not be an issue because they'll be under that $600 threshold.
DeleteRegarding "separating the token and yield", we do this using erc6551s or token bound accounts. more detail in my writeup, but these tokens are essentially NFTs that have an embedded wallet in them. We can use one of these tokens as a "Bank Token" in a consumer's wallet. That Bank Token holds all other individual $1 Flatcoins, AND receives all inflation offset Rewards based on the lumped balance. If you spend some of that balance, you no longer receive the rewards. It sort of removes the need for coinbase, and puts it all in an NFT. So an owner of a flatcoin can hold and earn, and then spend, and the recipient will then start to accrue the interest on that specific token.
On tax, I think you misunderstand. The $600 threshold isn't a trigger for paying taxes. Any amount of interest earned is subject to tax. i.e. even if a flatcoin owner earns just $30 or $40 in interest income, it's taxable.
DeleteOn the separation of token and yield, I am having problems following and would have to read more. But I still have the same question: does it create a fungibility problem?
ok, yeah, I thought all interest earned would be taxable, so then, why does Coinbase only issue the 1099 when you hit the $600 threshold? If that's what they're doing, seems like a similar strategy could be used for the flatcoin, no?
DeleteI’m a bit vague on the concept, but it sounds like a “flatcoin” is a way for a company to sell a bond with a fixed interest rate but not a fixed term. I guess the idea is to pay interest without calling it that? But this requires a flow of funds from investments. What happens when interest rates go down and the company backing it can’t pay the interest anymore?
ReplyDeleteStablecoins are very profitable for thie issuer now, but at near-zero interest rates, they weren’t.
sort of, the interest rate wouldn't be fixed. The idea is a token that comes within a few percentage points of CPI. But no promised fixed return. Chasing yield is an issue, but typically, as inflation heats up, interest rates tend to rise, as gov tries to cool things done (lagging for sure; and broad strokes here), so yield may be there consistently when we need it due just to the nature of our system. plus, you prob only need maybe 10% of reserves liquid at any time, so you could go out the treasury yc to generate returns on the other 90% to combat inflation. would also help if the token is widely used as a medium of exchange, and thus rarely redeemed
Delete"...that comes within a few percentage points of CPI..."
DeleteWhat happens when the token diverges from CPI? Can holders sue because their contractual guarantee to get a CPI-linked return has been violated? If not, what exactly is the nature of the promise the flatcoin is making?
well, a key part of this in the SECs eyes is what promises you make at the outset. binance got tripped up, in part, because of how they were selling their rewards tokens, ie. the marketing/promises they made. here, the flatcoin aims to maintain purchasing power, but we make no promises/guarantees. We can probably stress the compliant design (i.e. reserves held in tbills; bankruptcy remote and a qualified custodian with monthly reporting) and hopefully that will work to instill trust. But you have to be careful with how you market....so no promises.
DeleteSo the idea is to share a stream of profits with investors, and at the same time avoid being classified as a security under the Howey or Reves tests?
Deleteyeah, so Coinbase argues that 1st prong of howey isn't met becaues there's no investment of money, its just an abstraction of money, fully redeemable at any time, and 2nd prong isn't met because we're not earning a yield for the combined efforts of others. Plus, I think there's an argument that since any yield in this design would only be triggered if CPI rises, that isn't "profit" under howey...from the SEC's digital framework - "Price appreciation resulting solely from external market forces (such as general inflationary trends or the economy) impacting the supply and demand for an underlying asset generally is not considered "profit" under the Howey test." https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets. certainly not air tight, but could hold. Also, could potentially use same arguments for Reeves
DeleteCoinbase may not be the best source for securities law compliance. If you are planning to roll out a flatcoin of your own, I'd suggest you consult a securities lawyer. Some of the new interest-paying stablecoins do not let U.S. persons use them, tacitly admitting that they are probably securities.
DeleteYou say:
ReplyDelete"A flatcoin, by contrast, has been rendered incompatible with the dollars that we use in our speech. One unit might be worth 1.1145 times the dollars we use in our speech today, and 1.1147 tomorrow, and 1.1205 next month. This erases one of the most user-friendly features of money, its concordance with the commercial vernacular, alienating anyone who might use it for their day-to-day spending. "
I'm not sure I fully understand the argument here. We've had inflationary and deflationary periods that change the real value of the dollar over time, and nobody has ever had any trouble understanding the values in the short term. Yes, over time, someone might not know the real value of $100 in 1924, but that does not change day to day commercial language.
The argument I'm making isn't about changes in the real value of the dollar. I'm arguing that the nominal value of a flatcoin (i.e. it's face value) departs from the nominal value of all other dollars, say those issued by a bank. And that imposes a degree of inconvenience that handicaps flatcoin adoption.
Delete