Garret Jones - Applying Economics to Analyse and Rate Stablecoins

[Music] so next up we've got someone with a fantastic first name although they're not great at spelling Garrett from Blue Chip [Applause] all right so we got about one minute so if you're here in the morning you know that it's time to kill and I didn't know any stable coin jokes but I did ask chat GPT um and most of them weren't very good but one was close so uh paraphrasing what Chad CPT came up with why did uh UST Luna dalquan name it anchor protocol because UST sunk like an anchor not bad not bad so if those aren't familiar with blue chip I'm sure you're going to hear much more about this during the presentation but one of the more interesting questions lately has been how have you actually come up with like a ranking system for stable coins we need Moody's right and blue chip is provided so are you ready to roll all right so we're about to hear about the moodies of stable coins Blue Chip thanks very much do I have a clicker great so um the world needed a stable coin rating agency and uh some of us were thinking this should have happened quite some time ago it finally happened uh this week when uh my our team of three at Blue Chip launched the first stablecoin rating agency and so I'm going to tell you the story of how we came to be and really what I'm also going to be telling you is how to create your own stable coin rating agency there are some basic economics that underlie this that's the heart of the stable coin it's the heart of the Blue Chip rating framework is an economic safety approach and so we'll walk through this step by step together um do I have a do I have a page Clicker is this it yes yes great I'm trying to figure out which is up oh up and down okay great the heart of this problem is the heart of running any stablecoin well is what I call the stable coin Temptation which is that successful stable coins need to be packed by a huge pile of wealth this is what countries found out during the Asian financial crisis you can have a well-run economy you can have people who wear suits show up in meetings and say that your currency is stable if you don't have a big pile of hard currency backing your coin or your nation's your own nation's exchange rate You're vulnerable to a crisis so every successful stable coin in the near future will have to be back by some kind of big pile of wealth that means that equity-backed or algorithmically backed senior Rich coins just are not going to work the problem is that in real in real pile of wealth attracts people whether inside or outside the org who want to predate upon that wealth they can be doing this for completely nefarious purposes just people trying to steal for people trying to run late night votes on a dow to try to raid the wealth it can be people who run the organization saying I should hire my friends because they need jobs there's more than one way to misuse to misspend the backing wealth of any stable coin and both in the recent past and I'm sure in the near future we're going to find many ways in which the stablecoin Temptation will apply to real world projects another way to yes oh yeah sure great thanks I didn't know thanks very much so the it's these two parts the two sides of the stable coin Temptation are the heart of any rating framework first are you going to be able to judge in a candid clear way what the backing is of that particular coin second are you going to be able to judge whether the organization has found a way to overcome the Temptation for misuse and predation another way to put these together wealth attracts predators of wealth so um in real life banks have had to address this for a long time right real world Banks hold large piles of assets whether they're loans or tradable financial assets and when that happens we know that there's going to be folks who will be tempted to misuse that wealth or to raid that wealth one way or the other so Bank Regulators have a method that they've used for decades now both in the US and around the world it's known as the camel's rating framework and the two key parts of this that matter for us um and I mentioned this as a reminder that real world organizations have had to address the same issues as stable coins for decades so first the a in camels is looking at asset quality does the bank have a big pile of wealth second the m in camels is there uh is the management quality high enough has the organization found a way to scare off the predators of wealth so um Blue Chip has found its own way to evaluate the stable coin Temptation and we call this our smidge rating framework it overlaps in important ways with camels but it also takes pays careful attention to the unique nature of uh the world of cryptocurrency the unique Innovations of cryptocurrency including decentralized decentralized algorithms so so the smidge rating framework an uh an acronym looks at to focus on the consonants today stability management decentralization and governance s stability is really the stability mechanism underlying the coin does the coin have a huge pile of wealth underneath it the S also does look at recent Peg performance but if the previous talk taught us anything it's that a coin can be successful on 99 of the days and yet that 99 percent rate of performance has no information at all about whether the coin is stable or not in a crisis what we're preparing for in the world of stable coins is not whether have you done well over a hundred days it's not even have you done well over a thousand days it's are you likely with a very high degree of probability to do well over ten thousand days right this is how we evaluate real world currencies not based on three-year track records but on much much longer track records so doesn't have a big pile of wealth second the next the M the D and the G and smidge are all basically looking at different forms of governance and if there's one thing that uh the economics of the last few decades has taught us it's looking at again something that came up in the earlier talk that trustworthiness trust are hard to come by in real world among real world humans and so large organizations need to have a variety of mechanisms they're not just one or two solutions to this problem of trust and distrust each organization can find its own way to succeed at creating a trustworthy environment and many many humans over the centuries have found incredibly ways incredible incredibly creative ways to fail at creating trustworthy environments so this is part of the heart of any rating framework is having something that is sophisticated enough to notice the many different ways in which people can succeed or fail at creating successful governance there will be no one recipe for every coin there will be no one recipe for every Bank there will be one no no one recipe for any every Financial system um different they're different paths and that means having a framework that's flexible enough to evaluate these many different paths so let me tell you how to start your own rating agency first the first step is to realize people have done this already there are many rating agencies that actually work right there are many forms of grading that actually work we all know that movie reviews have some sort of value I'm sure that most people in this room have checked Rotten Tomatoes at some point to decide whether a movie is worth seeing it's not that you worship the numbers that you see there it's not that you treat them as infallible it's that you treat them as a useful signal right and there are multiple signals you can look at right you can look at Cinema scores you can look at Rotten Tomatoes you can look at audience views you can look at box office there's more than one path to evaluating that and that's just something we all that's quite decentralized that's a decentralized rating mechanism right more importantly we all evaluate many people evaluate cars through a rating framework uh and they're they're they're two major Market dominant forms of this I would say consumer reports and the JD Powers approach quite different quite different approaches to looking at car ratings Consumer Reports runs as a non-profit they buy the cars themselves they check them out for a while they ask their members of their group of their organization to evaluate the cars do you like yours how's it run for the last few years and the JD Powers approach is basically Mass surveys it's a for-profit organization both signals seem to be useful there's more than one way to evaluate car safety you might think well aren't these people all just bought off do Toyotas Only get high ratings because they bribe the people at consumer reports more often and with greater dollar figures than everybody else I mean to even ask the question is to answer it right we all know that Toyota's do well in real life and Consumer Reports is reporting the truth to us so somehow that model works even the bond agencies even the bond rating agencies Moody's standard and Poor's despite the criticism that came in with them after 2008 I still teach my students I'm a associate professor of Economics at George Mason I still teach my students and and especially in my graduate classes just go look at the ratings and go look at the Historical performance and accuracy of these ratings AAA corporate bonds corporate bonds that have AAA ratings have lower default rates than A's A's have lower default rates than B's B's have lower default rates than C's so this non even these for-profit organizations that are charging people for the rating somehow found a path to tell the truth so look at how those folks do this and you realize hey they need all of them need polyvalent they need multiple tools at work in order to evaluate the product and they need multiple approaches there's not just one website they check there's not just one algorithm they check there's not just one trait of the bond or the car they check second get the expertise to investigate these claims evaluating coins evaluating stable coins means going Beyond feels means going Beyond memes it means going Beyond market share it's not a popularity contest right where it means looking it means having um both the accounting and the economics expertise to evaluate to know that you're asking the right questions and you have the tools to evaluate them so in the case of the smidge framework this means having um at least one expert on hand who with an accounting with accounting background who can dive into reports someone with enough knowledge of the cryptocurrency ecosystem to be able to determine on-chain Holdings of assets that are credible versus those that are a little sketch so again this will mean going Beyond um looking Beyond looking beyond the hype cycle to finding details that are reasonably credible underneath another way to investigate The credibility of claims is to decide that you're going to trust audits many people make claims about what they have in the real world but not everyone has a an outside organization with a long-standing strong reputation come in and investigate those claims you know the United States went through some kind of a substantial degree of accounting scandals in the early 2000s but as it came out from that what happened is that people decided to trust accountants more independent audits are a way to investigate and decide whether to trust somebody's claim that they actually have a billion dollars in the bank a lot of people can say they have a billion dollars in the bank but having a a credible accountant a credible accounting firm certified publicly at the risk of committing a strong financial fraud that that person actually has that billion dollars is with worth quite a lot once you have this candid framework that you've come up with in our case it was the smidge rating framework it's important to circulate it to others people both formal and informal advisors this is what we spend about six months doing at Blue Chip before getting even close to rolling out all of our ratings you ask people like are we asking the right questions do we place the right weights on different factors is our level of collateralization within the range of what's reasonable sometimes you might think that some things just get solved purely by economic theory or purely by common sense but um one thing about common sense is that it's good to have four or five or six people check out your common sense before deciding whether to believe your own common sense so this is why um sharing and bringing in a wide circle of advisors was important for us at Blue Chip and I think it'll be important for anyone else trying to start a stable coin rating agency um it's the unknown on part of the way you get rid of the unknown unknowns in your rating framework is by asking asking allies and even Frenemies what they think of what you're doing so that turned out to be very important to just ask for people's candid advice it turns out a lot of people have a lot of great opinions and they're willing to share them so um what you're going to find out after you've created your rating framework is that you're going to need a blend of economics and accounting you're going to need a blend of monetary economics you're going to need a blend of organizational economics study of how people create trust and trustworthiness inside of organizations you're going to need some forensic accounting skills you're going to need some cryptocurrency accounting skills all and these these different skills the people with these skill sets need to be able to work with each other this is part of the evolution over the last 12 months of Blue Chip was the three of us on our team learning our different learning how to translate our different dialects the economics dialect the accounting dialect and the cryptocurrency dialect and learning to go back and forth in a useful way so we weren't just um staying each staying in our own separate holes but that we could each come together and find new insights so this blend of economics and accounting turns out to be important especially in the world of cryptocurrency because people are uh if there's one thing that we've learned from the great work of the late Robert Lucas the Nobel Laureate who passed away recently it's that people in financial markets are particularly forward-looking right they're making choices today about what they think will happen in the future and that sort of guesswork figuring out when people what makes people trust an asset's ability to pay off well in the future versus what makes them distrust or fearful of an asset's ability to pay off in the future means looking at the organization that created those assets and the team that's underlying those assets notice how much of this I've been able to talk about without talking about the details of either cryptocurrency programming or about liquidity pools part of what I'm looking at here with the stable coin temptation is that if you have I'm taking we at Blue Chip are taking the position that to a large degree if you have a good quality governance system in place whether that's a centralized human-based management system or a decentralized algorithmic system once those systems are in place the invisible the Invisible Hand finds a way to make these things work so management governance turn out to be Central we can't be sure of what's happening in each and every transaction on each and every part of the blockchain but we can be confident that if there are people in charge of the organization or a well-designed algorithm that's publicly visible that those those help solve problems that are even occurring at two in the morning so every organization that wants to create a rating agency anybody who wants to do that and I hope that there are many others who decide to do something like this we'll have to make some Forks in the world they'll have to make decisions about what their rating agency will how they will rate the coins so one is a traditional accounting question when you look at tradition in traditional accounting there are both measurable assets and unmeasurable assets like Goodwill or Deep Pockets so in uh when people measure the the market value of some firms you can see the market value of the assets that are on the books and then there's some sort of something that sometimes gets called Goodwill in traditional accounting we economists might call it Monopoly power or stickiness modern tech people would call it a moat those have some numerical that those have some cash value to them right those have some wealth to them but it is so hard to measure that at Blue Chip we decided we are not measuring this we're measuring the things that can be credibly measured we put zero value on Goodwill we put no matter we put no weight on the moat we put no weight on stickiness it's too subjective at the beginning for us that this is this is not something that we're measuring it has to be important to some extent right but when you have something that's important that you know you can't measure that's something you say this is for future research perhaps a year from now six months from now two years from now to be a good credible way to measure that another version of this that's more concrete is Deep Pockets um this is something that we talked about at the beginning at Blue Chip that if a coin were backed by an organization that both cared about its own long run reputation and that had enormously Deep Pockets there should be a way to find to find a way to make that a plus Factor I mean if a trillion if a company with a market cap of a trillion dollars you might be able to think of a couple if a company with a market cap of a trillion dollars decided to start a I don't know five billion dollar stable coin for some sort of small trading Network you would imagine that that Corporation would have some kind of interest in being willing to bail itself out into trouble just to keep its own reputation so Deep Pockets again should be worth something we don't have a concrete way to integrate that into the into our smidge rating framework at the present but somebody could make a decision to make a more subjective more judgment-based rating system and count that for a little bit of something right um Deep Pockets count for something in the United States banking system for instance if a bank if a medium-sized bank is owned by a large Bank holding company the the Deep Pockets of the bank holding company can be called upon to preserve to bail out the bank the FDIC can say hey megacorp even if you're I don't care if you were a grocery store I don't care if you are a shopping mall owner I don't care what you are if you own a bank and that bank goes bad we can we can call in your Deep Pockets on this so this means getting into questions of legality questions of bankruptcy law questions of FDIC receivership on some level that matters in that world there will be versions of that will that will apply to the world of cryptocurrencies it involves making legal judgments about worlds we haven't gotten to yet again a rating agency that wanted to do more I can say the words touch and feel but touch and feel is important right the world of Politics the world of bankruptcy law is a world where people are going to be making judgments on the Fly and if you're rating a stable coin part of your decision is to decide when this coin gets into trouble who will feel like bailing it out who will feel like saving it which investors will say I will put my own cash on the line these are judgment calls that will be made as versions of this decision were made over the weekend just a couple of months ago when it came to usdc where deep pot people are deciding how much of their Deep Pockets are they going to bring to bear on these questions again uh Blue Chips um we've decided that our smidge rating framework is sticking with things that are measurable that are concrete this is why assets matter this is why publicly doxed management matters this is why having your legal framework be set up in a country that has good rule of law and low corruption matters so we're sticking with concrete measures of course again real life sometimes turns on those things plus other more subjective factors that are important so um before my time runs out I should mention should you downgrade a coin because the government threatens to shut down that coin that's an important question at Blue Chip we decided we are rating the coin on its own terms assuming it is allowed to legally operate we let people know when there's legal action against the coin that's threatening the num one of the coins that we give an a to um actually has that uh is under threat for that right now but um we're rating the coin based on whether it's allowed to work whether it is likely to work we're not taking the government's government threats to shut it down as part of our rating system right now and um everyone has to ask what their definition is of a failed coin um with your when your ATM closes down over the weekend if your ATM is shut down your bank is closed on the weekend we don't say your banks have failed on a Saturday just because the teller isn't there so um we uh in the 19 in the 2008 financial crisis uh a coin had the uh a money market mutual fund with only failed when it lost three percent of its value so small deviations from a peg for a few hours that is not a failed coin in our judgment other people might decide differently we're worried about at Smith at um at Blue Chip we're worried about people losing the a substantial portion about massive failures of their Peg um two percent changes are not part of our definition of a failed coin but they may be for others so the world currently has exactly one uh stablecoin rating agency that is blue chip we hope that others will join us and I we we think that they'll end up starting with something like our smidge framework and changing it in small perhaps large ways adapting it to their own particular judgments but and that would be welcome because what we need now is a debate over how to rate stable coins in a clear candid and transparent way that can only help the stablecoin ecosystem work better thanks [Applause] hello uh I just wanted to peel back so I generally really appreciated the structured approach that you're presenting for stable coins in particular this idea of looking forward for example instead of looking at stability looking backwards you look forward but I wanted to challenge the application of this framework to Independent audits so when you trust an independent auditor you are banking on the past when you say a trusted and reputable auditor is putting their reputation on the line to attest under law that that you are presuming only based on past instead of looking forward in my mind any Reliance so I independent verification shouldn't have to rely on asking a third party to tell the world it should rely on the world being able to independently verify which is one of the benefits of sort of Unchained versus off-chain and in my mind that's why usdc and usdt are functionally the same because they both rely on an independent auditor whether you trust that auditor or not is a judgment call based on the past rather than the future sorry so I wondered if you had some thoughts on why you modified your your framework in this respect well um you know I had a professor in grad school John conless who said um you know they're all these economists talking about rational expectations and forward-looking behavior Rob Lucas Bob Lucas among them he says the problem is is that 100 of their data for looking into the future comes from the past I mean that's the only way human beings can learn is we have to look at things that happen in the past I write down models all the time that are perfect for site not perfect foresight economic models where I pretend you could look into the future but that's just a guess based on the past so um I think it's actually too much to ask many people to be able to uh evaluate on-chain claims about assets part of what our part of what we do in our smidge rating framework is make judgments about that and report it to others so if someone verbally says on their website a normal person can look on chain and see that these assets are there how will a new user know whether to trust that claim that's part of what we can do with the smidge rating framework is say we have looked at those on-chain assets and we believe those claims but if someone's talking about off-chain assets particularly when someone is talking about off-chain assets that's where an independent audit is the best path forward in the world as we know it so if someone says they have a billion dollars in a bank account I'm going to be looking for um someone signing that document in a way that doesn't that uh is putting their own legal putting uh making a legal statement that could be contested in court that's the kind of kind of statement I'm looking for and again I could say that's actually something about the future right you're making a statement that you will be drug into court in the future if this is a lie or a material misstatement please hi Garrett um thanks for the talk and for launching Blue Chip I agree with you it's a highly needed and I'm really glad that we get a the first table converting agencies calling for more already you know I think it's a very healthy Behavior so congrats on that um I wanted to ask you questions regarding governance uh so for the stable coins that are that have active governance in the one you you support in the rating is it envisioned to essentially how do you account for the fact that what you have right now is a snapshot at present time so we evaluated those coins now but I think what would be very interesting with blue chip is to be able to see how this ranking evolve over time depending on the governance decision and if I can project into even the ideal situation there would be even as those projects are discussing potential potential changes kinda you guys hopping in and being like hey guys we modernize your Envision change and that would essentially have this impact on the rating you know be able to essentially help those projects guide uh guide those projects in in those uh changes they make through the governance yeah that's a great question we are actually we're going to be starting updating within weeks right continually updating and renewing not just the easy to check financial statements but statements about the management and governance and decentralization scores of each coin updating those regularly is part of our process and we already if you look at our ratings online at bluechip.org you can see that for every coin that's not at the highest or lowest level a or F for everyone a minus through D we actually explain the most important things that any coin can do to improve its grade so that's real I think we're trying to help people we've already had some folks at running uh stable coins reach out to us and say that they would they have information that they think is useful to us so we think that conversation will continue in the future and it's important for us to get the most accurate information possible we will be we will not be being skeptical is an important part of being a stablecoin rating agency I think you can all appreciate that um but um information that can be accurately independently verified or information that's very transparent is very helpful to us so all right uh thank you very much Garrett foreign