What is “Good Enough Yield” and Acceptable Risk? Panel

Good morning everyone. I am Mike Masari, strategic advisor at Restston and very very excited to have this wonderful gentleman talking with me today. We're going to talk about what is good in a field and acceptable risk which are usually two topics that are very intertwined and sometimes people think about one or think about the other. Uh today we're just going to try to talk about both. Uh I am joined by Charles Jansen which is head of DeFi transformation at S&P Global.

Uh and then Ash Morgan which is head of stable coin and RWA at the Ethereum Foundation. And finally Mark Bon, I hope that I pronounced that correctly. Uh which is the CEO of Polygon. Uh guys, I will let you introduce yourself very briefly and then we'll jump out to the questions right away. Uh Mark, why don't you go first?

Yeah.

Uh sure. Uh as you said, I'm the CEO at Polygon. I'm also a contributor to Katana. It's a D5 focused uh L2 and super app. Um before being CEO at Polygon, I was a DYDX.

Um where I was the chief legal officer for that doing legal work mostly in DeFi.

Awesome. Ash,

so I'm at the uh sorry guys, I've got a bit of a crack voice from the last couple of days, but um I work at the Ethereum Foundation prior to this. um co-founded a um you know a non-custo staking network uh predominantly focused on APAC um working with institutions to onboard them uh into the sort of Ethereum staking world and just you know in general um you know the the blockchain space. So that was the background and then joined um with the [clears throat] Ethereum Foundation 5 months ago to uh do a lot of coordination with the ecosystem and then institutions uh around their go to market strategies on both sides uh to meet in the middle uh and uh have product market fit around real world assets and and stable coins.

Hey, I'm Charles Johnson. I lead digital assets at SNP. uh I need to explain often what S&P is. So people uh relate. So that's the leading uh uh credit rating agency, leading index provider.

We created a risk assessment for stable coin. We rated the uh sky protocol not long ago. We got many other type of of rating of the sort. We tokenize S&P 500 with centrifuge and we got many other initiative. Yeah.

Awesome. I am thrilled to have you all here and I would want to jump right into the question if you guys are okay with it because we only have 32 minutes and a lot a lot to talk about. So I was saying I start a little bit with an a hypothetical, right? And I know that you know Marson was in the panel before and he likes to talk about hypothetical things and people like to speculate a lot on on what could happen. But if you had $1 million today to deploy into one strategy for one year, what APY would be, you know, good enough field for for you?

I can start if you want. We don't deploy. Right. So I asked somebody uh that is in the audience which number I should say. He said 80% because that's what anchor was.

No. So uh joke aside risk assessment is what we do. And you know when we started this team in 2022 before taluna nobody cared at all. So well if I was to deploy it I would definitely need and many institution have this this need to have visibility on the risk. There were two limitation that we always had in the field was the lack of regulation and the lack of visibility on risk.

So yeah that's yeah makes sense. I think you guys are doing some great stuff right like it's super important that SNP are involved in general. Um you bringing a lot of legitimacy to DeFi. So we hope to to continue to engage there um as an ecosystem. Um on my side, hard to say.

You know, the Ethereum Foundation on on that front, we um we deposit a few assets in some of the major D5 protocols. So I think we're not chasing tons of yield at all, but um different risk tolerance with with a treasury such as the EF. Um, personally, uh, at the moment I I'm I'm pretty long ETH, so I would I would do some staking. Maybe in the LSD space I chase maybe five to seven, maybe up to 8%.

Yeah. And for me, it just comes down to like basic finance, right? Which is how much is a million compared to net worth or my company's assets. Um, if it's a big portion of it, then I'm going to look at treasuries and I'm going to look for some tiny yield on top of that or sit in treasuries. Um, you know, if I'm older, then I'm going to probably uh be more likely to stay in that.

If I'm uh young, it's a small portion of of my net worth. Then uh yeah, I'd probably be looking for 10 15% returns. if I lose some money, it's got many years to make it up. Just kind of basic finance 101.

Yeah. And it's interesting that all of your answers were all based on risk, right? Because this is kind of the core of what we're discussing that yield and APY especially is not the only thing, but there's also many other factors to consider. One of them being for example, how the APY is calculated, right? And like where it comes from this APY.

So lots of people they just stop at the number in itself and they say oh my god like 100% APY or 80% APY that's awesome but maybe is not that awesome. So what are you know the factors for example charts in in your mind that people should care about uh to understand and assess the risk of these investments. Uh so well I'm not on the analytical side but so that said I can I can answer. Um one more thing I wanted to mention though there's the yield there is the risk but when you speak of institution they care a lot about correlation also. So for instance you mentioned staking yield well I think they're fairly uncorrelated to many other things.

So that's one more factor. Now when you look at the risk well that's what we did for the the stable coin stability assessment like the the risk of the underlying is always something you should look at like if I don't know you have a vault uh the the first factor will be okay what is it investing in but then there's many other factors there is how the the operation of the team doing it well you saw what happened with uh with Paxos and PayPal when they minted uh $100 trillion dollar by mistake That's an operational uh mistake, operational risk. uh you have uh you look at the track record of whoever is is is managing this of course now and that's something I I try to explain a lot in trai is we start to have with for all the tokenized uh asset we start to have a convergence between classic cyber risk web three more type of cyber risk including smart contract but not only and credit risk While you can in some case well remove some of the comp counterparty risk. So there's many many risk to look at. Of course some company can do it usually retail is not very interested in it but many institution need independent third party to look at this for them.

So that's what we try to do. Yeah, I think on the product side, I totally agree. Go one level earlier and you know um [clears throat] to the base layer blockchain risk in general um today institutions when we talk about real world assets a lot of those um you [clears throat] know are and have a home offchain. It's only when issued natively these assets, it becomes a lot a lot more of a risk. Blockchains in general and when we're talking about 30 40 different products on a chain becomes incredibly hard to roll a chain back.

Um, one financial product broke because the chain went down, 39 didn't. Becomes a lot harder to justify to roll that chain back. And I think we're increasingly going to see a world in which um the risk teams at these banks care um more and more about the blockchain. So that's that's generally speaking how we approach things. Um going to um the product layer, the idea here isn't to take finance and just add a wrapper around it.

The idea is to reinvent finance, right? It's to take what exists and 10x it. And and that means taking a mortgage back security and enabling it to be traded off the balance sheet in a day, not 45 days, not 30 days. And how do we get to that? We create open, transparent um, you know, financial products.

Yes, a lot of privacy around who holds them, but in general, the product itself, you know, has to be super transparent. And I think that comes, you know, [snorts] with Oracle infrastructure, with ZK, um, infrastructure around these financial products to look on the inside of them, you know, who makes up a mortgage back security, who what are all of the people, the the mortgages in each tranch, what are their risk profiles and, you know, anonymizing all that data. This becomes a product that's incredibly attractive to asset managers who have exposure to these existing products. you know, that costs a lot of money today, but we're increasingly um cheapening, you know, the way in which you can build these products. And that that to me is where we need to continue to push.

Yeah. And that's an very interesting point I think that you raised Ash because um one of my questions which is very appropriate to what you just said and it's a question for you and for Mark is do you think that a chain level there should be a more like systematic approach to this yield products cuz now they're effectively just like a byproduct of the market activity right but the chains or the foundations did not necessarily create products specifically for yield do you think that that should happen

I mean I I I think uh there's this history of talking about chains uniformly. Uh and I think very soon we're going to see that like never happening again in about a year from now. Like it'll it'll end completely. Um like Ethereum should be completely neutral and that's it. And people do whatever they want on Ethereum and it's it's that simple.

uh a chain like katana defi focused chain has instead of a what I call a lazy bridge has an app as a bridge builds an earn product into it like probably kana needs to pay attention to you know what what's actually being offered through through that interface so I look blockchains especially like completely permissionless decentralized blockchains are meant for people to do whatever the heck they want on them um and they should have fun doing whatever they want your responsibility comes up when you decide to surface something to people and what you surface them is is something that that you should really think about. And I think like a lot of the risks mentioned I think were were really good. I think like the correlation is probably one of the like least understood risks I I'd say in in crypto like one of the most understood in finance although hardest to like maybe like simulate but um one of the least understood in in crypto that I think is a is a really big problem. But like just on that risk point, like if you were to go to like uh a lawyer and say, "Hey, what are all the risks?" They'll literally we can draft a 20page document on like takes so long to trade these things because the lawyers have to look at every page, right?

Yeah. Yeah. Exa. Exactly. And so, um I would I think one thing that might not be popular to say, but like I don't think DeFi lowers your risk at all like at all.

Um I think what it does is increase efficiency which means you can actually maybe get a better risk adjusted return. Um but I don't actually think it changes the the risk itself in a in a meaningful way like the same risk that exists I think exists on chain. Uh and in many cases it's actually just more hidden um which is which is problematic but um there's a lot of work being done on surfacing it which I think is great.

Ash do you have anything on the foundation side as a counterpoint to that? Yeah, I guess um well like we we constantly talk about like Ethereum security, right? And the risk, you know, the risk premium to access yield across the different chains. Um I think like we're targeting you know that area significantly to ensure that people um are comfortable uh operating on Ethereum issuing assets on Ethereum bridging across other environments but the home you know the the issuance being um on Ethereum I think that's that's how we're viewing things Ethereum as a storage um of uh you know a base storage of all of these assets um increasingly So, uh, Ethereum is the home of these transferable real world assets, stable coins. Um, uh, I think that's that's our focus.

That's what we're communicating. This is the edge that Ethereum has. It's the it's the most secure, uh, high upane high uptime chain there is. And I I, you know, constantly reinforce this message and the basically the data that supports that statement. You know, we launched institutions.

thereum.org the other day. Please go check it out if you haven't. And um you know we we go by market every single market we use all the data providers RWA.xyz and we give a very clear picture of of of exactly what I'm talking about here.

So when you guys look at for example RWA or stable coin and like charge maybe this is a question for you in in the first instance is how do you define effectively what is acceptable risk for these assets that are like such at the core level of of an ecosystem and then I suppose follow-up question for for you guys do you think that the infrastructure that we have currently is good enough for that risk to be mitigated or do you think that the chains should have a bit more of a say into the way that this risk is assessed and and mitigated.

Okay. So, we don't define what is acceptable risk. The the the role that we have is to provide visibility on risk.

Yeah. And sorry, the question was like what what are the factors that that you define like within risk and and what is acceptable like acceptable factors as opposed to acceptable risk.

Well, the acceptibility is really at the and that's an important question, right? the accessibility like what do you accept as risk is really at the investor level right the problem we have in the field and we had many many many time had visibility on what actually was risk and it's still the case in in many conversation I got conversation with insurance company and there are some insurance company that do for instance slashing risk but there are [clears throat] people that work with them that are uh concerned that well there are many other risk around staking they're not necessarily related only to to slashing, right? So what is needed is to have as many and as deep framework of risk evaluation with the goal not to define what is acceptable or not but to with the goal of pricing the risk. Now if you have a very that's the topic here right if you have a really good yield with a very high risk I mean some people will take that chance not everybody wants the less risk in the world the lower risk in the world because well you usually will come with the lower reward in the world so uh for for us it's really bringing the the visibility on the risk now how it's done well will depend on the product and again it's more the analytical side that look at it for stable coin I wa like for instance if you want to have a rating on a a stable coin. We since it's a stable summit, right?

We we don't have a specific methodology for rating stable coin. We have a methodology for the risk of DPEG of stable coin that we created which is a different product non-rated. uh if you want to have like like um uh well sky indirectly had but they are any stable coin could be raided most of them if they are not um uncolorialized then the way it works is we create a framework for that where we'll have a basically a deck from whoever wants the the rating on their product. It will go to the analytical side which now has a group of expert in uh digital assets which was not the case 5 years ago. We didn't have that and they will be the first one to review the the uh well the products that need to have the risk assessment.

Then it will they will add people from the depending the structure from the funds team from the uh structured finance team and they'll look at how they will decide to look specifically at this structure because speak of stable coin they all target the same thing they all want to target a peg but they all do it in different way so so that risk analysis is really uh not bespoke but will depend on the structure and the way it works is really for is having or let's say they define it really look like a fund then you'll have all the methodology and and the analyst from the fund side working with those from what we call D5 but include also centralized finance looking together all the risk so it's not like oh there's one way to look at the risk and here it is the one we had

yeah going again back to Ethereum specifically we we have an initiative you know the $1 trillion security um initiative. And um and so the the idea behind that, right, is is we should at some point um be able to store $1 trillion in one smart contract. Um you know, that that is the target. Um we're pushing um further and further into this line of thinking, right? What does it mean to have an indestructible network?

What does it mean to to be up at all points in time? And I think like the the there is an a push here to red team you know Ethereum both at the consensus and execution layer. Um this is something that realistically has not been engaged upon. Bug bounty scaled to a certain point. Um but but we uh we are focused you know entirely on this and building infrastructure around Ethereum.

So, AON, to your point about ensuring, you know, against correlated slashing, you know, they've I think they've wrote a $60 million policy not long ago. Now, I know there's there's teams that are that are chasing $1.52 billion worth of correlated slashing risk um you know, insurance. And so the reality is there, you know, with some of these big DATs, they're fine to pay 100 to 150 basis points. Um because ultimately they're long ETH and they they they aren't um wanting to lose any of of their ETH due to these correlated slashing events.

So you know the one, you know, 150 basis points yield is enough for them. So it it completely depends on their risk tolerance, the way in which they're they're interacting with Ethereum and that to me it's it's finding um and pricing the risk to your point and this is this is the internal modeling of all these teams like they they they're ultimately um they're ultimately all looking for different things. Um and I I um I believe that the the the liquid staking the even the restaking is super interesting. So as long as we um take a sophisticated approach there to decentralization of of these different service providers and you know symbiotic an interesting case you know enabling all these different restaking protocols um you know uh to to to come the liquid staking products and and you know to to have that um basis of decentralization there liquidity I'm I'm sure will we'll have problems there and we'll have to work them out over time but you know making ETH a productive asset for us is is a big focus as well like making it you know let's look at just the restaking products that we can build right so we can on offer you know this this this ETH um to back insurance products offchain now there is this again correlated piece and there could be systematic you know contagion risk that we we need to look further at but making ETH a productive asset is super important to us as well so you know building from you know 50 basis point yield on on staked ETH right up to you know 10 to 20% is is probably an interesting proposition for those that have exposure long exposure to ETH.

Um yeah in terms of like the the idea of like acceptable risk um like I I don't acceptable risk is whatever somebody wants to to earn. Like for some people in certain situations like 40% yield actually makes sense. uh in other situations like 3% yield makes sense. And so uh I don't think we should be defining that. Uh I think we need to do like a 10x better job of like laying out what those risks are.

Um I think we need to continue to do a better job of laying out what the the actual yield is, right? Because like one of the risks is your yield is not actually your yield because so much yield in DeFi isn't actually real yield. Um but people should just choose what they think is acceptable to them with like the right information. Yeah, I agree and ultimately it's a matter of visibility, right? So you said it to yourself and and Mark as well people should determine their own like risk factor and what is acceptable but our job probably as blockchain people or as an infrastructure is to show that risk and like communicate that risk to people.

You rais a very good point between you know what is like the headline yield right and and what is effectively the risk adjusted yield. What are some ways that for example people in the audience can use to determine or to at least have an idea of how much difference there is between you know like headline APY of something and the risk adjusted APY. I think today well this is why S&P is getting involved right because there is a demand for this as as asset manage man managers increasingly see the opportunities on chain um you know to access and these are global participants that want highquality American assets that have traditionally been a hop skip and a jump to get access to now they have it on chain um you know they're the ones that really are pushing for this the retail audience you know I think like just to give a bit of context X on that 21 22 boom D5 boom right that that was 98 plus% I would guess um you know Wales on Ethereum and just retail participants who who engaged um in the you know basically yield um farming and yield uh I guess like wars like in general like looking to earn governance tokens to be a participant in the future of the financial markets and a lot of people lost a lot of money during that period. there were a lot of hacks. We've increasingly you know gone um you know down there with respect to how much is lost in these smart contracts hacks over the last 3 4 years.

So different environment. We've never got back to those numbers yet, but now like we we are seeing real adoption, real real exposure here. And I it to me um it's it's going back to to where it was. We were chasing extreme, you know, yield and and opportunities. And now it's it's real.

you know, these are asset managers that have not traditionally been able to get into America, you know, with some of these high quality products. And I um I think that that that in of itself, the sophistication that's coming into it, they'll demand more and more frameworks. Now, how and what are those frameworks? Like that this is the opportunity. You know, I see Redstone, you're releasing like your lowrisk DeFi um you know um ratings um product and that's great.

We need a lot more of that. I know L2 beat is doing great things um with respect to just you know chain you know L2 chain risk and and the stages that that we go through maybe we're a little hard on the you know stage two piece so I think we're going to rejig that just a little bit I know Vitalik and all participants to to Marsh we're all working now with Kristoff the the founder there of LTB to to rejig that a tiny bit because there are I guess like it's become this pretty unachievable um structure um you know to hit that stage too. So there's all different risks across the the the page. Um and I think that institutions look at L2B. It's it's remarkable.

We hear about it all the time having these conversations. So more of it I this is a hard problem to solve and it's a new risk um you know environment um all the infrastructure. So yeah,

one of the things that I I I actually think needs to be like addressed is we talk a lot about like the the infrastructure and risk around that and like things of that nature. Um but there's like um there's two things to me that are like pretty basic that are like very broken right now. I think the first one is uh around collateral. Like the idea that like collateral is going to get like changed and your risk profile is going to change with like no information other than like it just happens is like so so absurd. I think the idea that like people are going to go to forums is so absurd.

Like there was a day where like that's what I would do back in the day. That's like what like web3 natives do. But now you've got all of these apps that want to just give yield to people and um like you sure as heck better be getting their email addresses and like sending them an email that says the underlying collateral just changed and your risk just went way up. Like that's a massive problem that people like don't get that information. Second one is like dexes and lending protocols are so different.

Like Dex is like they're decentralized. Like lending protocols like we got to get rid of this like idea that like lending protocols are like decentralized. Like there's a curator who makes like very meaningful decisions around like your risk. Um the a DAO controlled by one person or two um they make very meaningful decisions around your risk. Like that is something people don't understand.

It's conveyed in the same way as like dexes are conveyed, but like the risk is like insanely different because it's a small number of people or a team that is making those decisions and that is no different than asset management elsewhere and it should be viewed in that way. The only thing is the underlying infrastructure is more efficient and that's great. I think you can like leverage that to get get better riskadjusted return, but like that asset management part is like real and like we need to treat it that way better because people are going to end up getting like super hurt one day. Um, so anyway, a

little bit. Yeah, the other day, right? Like I guess like that's a good example of it.

Do you think this is a a regulatory problem or do you think that this is an information problem? So how do we approach the the the issue right? So you you are highlighting how maybe a handful of people you said like one or two people but like a handful of people in any given protocol they effectively make this decisions and people that invest in these protocols they don't know uh and they don't understand what happens. How do we how do we approach that like in a systemic way?

I think um ultimately with that right like the infrastructure bill I negative, positive. We probably should as an industry just think about self-regulation. Um, we're moving too quickly um for regulators um you know to to realistically understand all of the innovation that's happening and that's it's difficult to self-regulate, but this isn't the AI space. This is this is core financial infrastructure um that that requires you know each each new addition to this stack it requires a testing it requires putting it out into the open. The only way this stuff ends up being you know truly riskmanaged is by use.

Um so to to limit and regulate this use today would be a travesty is is how I would think about it. Um, you know, there is the yield opportunities within these these early stage DeFi primitives and and protocols and vaults that we're going to learn all of these things from. They're paying high yield for a reason. You you might lose your money. You might lose your stack.

And so that's why you're getting the yield like that you are. And that is all codified. That's all in the history book of this space. And we learn all the engineers learn from that. and and to say that you know each and to define new categories in this space and say hey this is the regulation this is how you should do things it's just not how it's going to work um we need to continue on the path we are and just take and bring in new participants like S&P Global you know and other ratings agencies and invite them in and and explain these products um that's the key piece in my opinion

so I used to think exactly like you then well I but maybe a slight different view right now. So I think regulation espec well it depends who regulate and their motive etc but like for instance the ECC right now is not the ECC we had two years ago right and uh it it depend what your goal is if you want to get the trillion from the institutions in I mean with the for instance stable coin BXA we see the impact that some regulation can have in enabling the field right so it does then if it's done in a good way in a bad way. Everybody can can debate but the regulation can be made as a basis that defines how you know basically what you can or cannot do right if you want the banks in they need to have the rules of the game if you don't have rule of the game they won't play right the asset manager can do different things so I give you an example and and how S&P for instance relate to that when we spoke with many regulator was when we when we speak with regulator and we speak with regular regulator all the time. We were explaining what was the the stable coin stability assessment and some uh when the the the stable coin bill was being done told us yeah well you're kind of doing the same as what we're doing eventually it's useful now but when regulation will be there what's the point well they there are different layer in fighter right you have a regulation on how bond should be and and all those kind of things still you have different rating ings on those bonds. So it serves different roles.

So the regulation is not necessarily for like defining the risks that you should be accepting etc. But it's it's important to have it to define the role of the game right because there is existing regulation you have accredited investor all those different things. So somehow if we want defy to become something really real and accessible well you'll have to pass through the step. the ideal scenario is that when it's not well killing the field and and it's done in a way to enable it which now I think the the overall white house angle is they want to be the crypto capital of the world when they say crypto they mean blockchain defi etc. So if they can set up the rules that basically enable participants to get in, then it's productive.

Yeah. I just think this is a [clears throat] transformational product. So I push back a tiny bit. Like the Wright brothers 08 to the first commercial flight was 30 years later. I think the rules of this game, we need to spend a lot longer working them out before we say, "Hey, get the government in and and say this is how the plane should be built."

You know, ultimately the engineers need a lot more time. I think we're still so early. We got four or five years of DeFi experience. I think we need another 10 to 15. I don't think we This is going to take a long time.

I I would say, you know, I'm less bullish on putting $5 trillion on chain right now. This is going to take a lot longer and people's expectations should be, you know, um drawn out. In my opinion,

yeah, I I like tend to agree with you. I think it but but it does depend on how you like approach regulation, right? Like ultimately whenever you say like let's not have regulation, what you're basically inherently saying is some people are going to get hurt, we're going to learn from it, then we'll get better. And that's that's like a better way to do it. I I tend to actually think that is a better way to do it.

And you end up having again like rating agencies and and like forced disclosures from like public pressure and like people start writing articles about how you know you continue to have issues and then suddenly the only way to fix it is actually through you know somebody finally saying okay well unless there's risk disclosures on this I'm not going to do it and then people start paying for risk disclosures and then you suddenly have a market that gets set up and like you're in a good spot and the question always is okay are you okay with some people getting hurt initially? um that's like literally how it works. And what I would argue is we're going to get people who are going to get hurt anyway because regulators are not going to be able to figure it out properly fast enough. And so um we might as well let the markets figure it out. And then lastly, I'll just say like consumer protection is something that exists in laws anyway.

Um and consumer protection just requires disclosure. So just disclose things properly and you already have laws that deal with it. And frankly for people who are not disclosing and are creating tons of issues like and frankly like hiding things like honestly somebody should go after them like don't hide stuff just disclose it.

Yeah fair enough. Thank you so much for the conversation gentlemen. It's been wonderful to have you here. Um that's all my question so far but if you have any from the audience please come find us. Thank you for joining me.

Thank you.