Beyond the Peg: Credit, Collateral and Counterparty Risk in Stablecoins

Transcript

Good afternoon, everyone. Uh I've been hearing the last few panels and maybe I'll spend the next 8 10 minutes kind of answering the question that most of the discussions currently are about, not only on the panels we heard, but also in the capital market industry. And the question that sits underneath those discussions is not which stable coin is the biggest. It's not which protocol is the fastest or more efficient. But the question everybody is trying to ask is or understand is which of these are safer or safe.

And more importantly, they are trying to understand how would we even know if they are safe, and that is what this is about. So, let's start with where we are. Traditional financial infrastructure has a lot of friction. We know inefficiencies exist, but we've identified three main topics or three uh expensive, measurable problems that we have been tracking for a while. There is almost 240 trillion dollars and over of liquidity trapped across fragmented uh financial systems that were never designed to talk to each other.

That's the mobility problem. There are almost over 100 billion dollars are spent annually in the industry to reconcile data across those fragmented ledgers. That's the volume problem. And we see almost 10 trillion dollars of foreign exchange turnover every single day. And our settlement speed and execution speed is is completely incompatible. That's the speed problem. And these are not projections, these is actual cost that the industry pays to run markets and do their business today.

But the evolution is showing us very very different scenario. We are seeing emerging markets, private markets, credit markets, and digital economy all converging. It is all happening together. Innovation is not happening in an in isolation anymore. What we are also seeing is that digital finance sits in the middle of all of this convergence today. We are seeing new data types and new instrument types being innovated every day and being circulated every day.

Imagine an an AI agent making a financial decision autonomously on chain. The question of how the financial systems and which data points the financial system should trust becomes very urgent uh that has never been seen before. So, digital finance is creating new risk layers because of the new data types being created. And how do you identify and evaluate those risk layers becomes the question. And digital finance and digital economy overall with all the emerging technologies and the data center evolution is not a subsector anymore. It is becoming a connective tissue of how the capital markets are going to be working

in the near future. And this has not happened overnight. The convergence has been going on for a long time. It started with digital bonds back in 2016-2017 when the first digital bond was issued in the capital markets. What that did is that it proved that the digital infrastructure layer could host a regulated rated debt instrument that can live on chain and can be trusted. And that proved that the technology is here to stay. Then we saw the evolution and expansion of tokenized funds.

They grew over time and and that what that proved is that the invest that the infrastructure is going to be embedded into our capital market systems to solve the problems we saw on slide one, but also at the same time, it confirmed the institutional appetite of uh having to issue more and more tokenized and digital assets using blockchain technology. And now we have stable coins that are growing fast, faster than any other asset potentially ever seen uh in history of capital markets. They're growing at a rate that has not been seen before.

And stable coins are not growing as a crypto curiosity, but actually something more consequential as the settlement layer. They're actually look being looked at as the potential stable cash leg of the tokenized economy. And that's where their credit quality becomes very important in in the institutional uh arena. All right, I'm sorry the formatting has been uh distorted, but I hope you can see the text. The three problems I spoke about in the first slide are not looking for solutions anymore.

Market is already responding to them. So, tokenization has the potential to unlock the trapped liquidity, and stable coins can potentially settle them. That solves the mobility problem. Shared distributed ledger can eliminate reconciliation, solving the volume problem. And um uh atomic settlements or instantaneous settlement can potentially close the FX exposure window, solving the speed problem.

But if you go beyond that, you will see that stable coins actually sit at the center of all of this evolution. Behind the scenes, US denominated stable coins have actually been driving digital dollarization in markets where financial institutions have historically not had a major footprint. Uh major income and payment play income and payment providers and infrastructure providers have stopped fighting stable coins, but are finding innovative ways to integrate them into their infrastructure and and and financial markets.

Stablecoin issues like Tether hold more US Treasury debt than some of the mid-size sovereigns that we've seen. So, stablecoins are already moving from a parallel system into the core infrastructure. And regulators have noticed. And they are actually supporting this innovation. What you see on screen is a map of regulations either being active in draft consultations or early stage considerations across the globe. And this is a non-exhaustive list. The signal is unambiguous.

Mandatory reserve standards, redemption rights, operational required requirements are all arriving even if issuers are ready or not. And stablecoin issuers who will be able to prove the credit quality of stable coins in line with the regulatory requirements will be the ones that will move through the transition phase of going from an unregulated crypto ecosystem to a more regulated core infra financial infrastructure. So, some of you may be thinking why am I talking about credit quality?

So, what is what what does he even mean by that? Let me ask you a question. If you were buying a house, any house, would you give away your life savings without getting an independent structural survey done? Of course not. You would want an independent surveyor to actually go into the house, look behind the walls, look at the plumbing, look at check the foundations, and give you an independent honest verdict before you actually put your life savings in the house that you want to buy.

Credit rating is a similar is a similar construct. It is a forward-looking opinion uh to know how an issuer or a financial obligation will perform over time over its lifetime, especially under stressful market conditions. And that's exactly what we are going to we are focusing on at Moody's credit Moody's ratings today. So, what are the risks that need to be assessed if we ever have to evaluate stable coins?

We've been tracking stable coin evolution for years. We looked at a lot of data that is available out there. Most data is of course in DeFi and uh crypto markets. And we identified risk indicators and areas of risk that need to be evaluated to assess a stable coin for its credit quality. And we bucketed them into these four boxes or circles on the screen. First one and foremost is collateral. The underlying reserve, the reserve quality. This is where uh the entire credit fundamentals of capital markets sit.

The capital is allocated only based on the decision of the quality of the reserves that the asset is going either providing or sitting on top of. So, we start from that very credit fundamental to check what sits under stable coin. Is it sitting in a bankruptcy remote account? What happens if 30% of the stable coin holders or investors decide to redeem their stable coin at the same time? Does the issuer have enough liquid assets or cash to continue holding the peg of the stable coin to be one to one? Second, transaction structure.

Very important as well because legal enforceability in capital markets is another important aspect that needs to be understood from a credit fundamental viewpoint. Is your stable coin or is it is your digital token of any asset enforceable in a court of law and which jurisdiction can you actually assert that claim? That's what we try to identify by looking at all the information underlying the stablecoin. Third, operations and counterparties. Minting and burning mechanism.

Governance structure. Everything is very important as well. And we need to work on those. And last but not the least, technology risk. Smart contract audit, Oracle risk, uh key management, custody risk, et cetera. I'm running out of time, so I'm going to jump really quick. So, we evaluate those risks as well. And these four risks required a rigorous comprehensive risk framework, so we decided to build one. And therefore, we published the first uh world's first stablecoin methodology back in March that literally answers the question if the holder can uh redeem at par on demand and uh under stressful conditions. And of course, it's globally applied. It's portable with the stablecoin in the

jurisdiction where it can legally stand. And beyond that, we also went ahead and evaluated the digital finance ecosystem and bringing in our 117 years of expertise and trying to understand how can we make our credit insights programmable, which in today's world sit in the in the web two world in a static way in reports, press releases, and credit opinions. So, we decided to uh develop and launch token integration engine, which is network agnostic, that makes our credit insights continuous, adaptable, and and is network agnostic.

And we are currently uh the pro- probably the only credit rating agency with a with an active operational nodal infrastructure with a node on the Canton network, and we continue to scale from there. So, I'll be off stage, happy to continue the discussion and talk more about what I shared today. Uh thank you for your time.