Techopedia interviewed Garett Jones, co-founder and chief economist at Bluechip, to learn about the methodology employed by an independent nonprofit rating agency in assessing the credibility of stablecoins and providing guidance on which coins appear to be more secure.
What is Bluechip?
Q: Garett, how long have you been nurturing the idea of creating an independent stablecoins rating? Who are the people behind Bluechip, and why do you and other co-founders consider this rating a must-have in today’s stablecoin landscape?
A: The idea for Bluechip, a nonprofit stablecoin rating agency, has been in development since the summer of 2022.
Our team of three is made up of our CEO, Benjamin Levit, who brings expertise in online commerce; our chief ratings analyst, Vaidya Pallasena (known online as Deathereum), who is a chartered accountant with a forensic mindset; and myself, a monetary economist with a background in writing about banking and exchange rate crises and the challenges of establishing robust social institutions.
Given the growing importance of stablecoins in the financial ecosystem and the need for a credible voice that separates the wheat from the chaff in the world of so-called stablecoins, we believe an independent rating system is crucial for market integrity and consumer protection.
SMIDGE: An Unbiased Rating Framework
Q: What framework do you employ to assess stablecoins? Tell us more about SMIDGE. Were you inspired by the internationally recognized CAMELS rating system used for financial institutions?
A: We use the SMIDGE framework, which stands for Stability, Management, Implementation, Decentralization, Governance, and Externals.
Currently, we’re just rating the consonants. A quick overview, with more details at bluechip.org:
- S is whether the coin is sufficiently backed and whether it’s kept its peg in the past;
- M is whether the management team is above the bar on trustworthiness;
- D (only for on-chain coins) measures whether decentralized coins offer the privacy rights that are part of the promise of on-chain coins;
- G measures whether the stablecoin holders are sufficiently protected by corporate rules or government statutes.
It’s a comprehensive approach that evaluates various aspects of a stablecoin, from its backing assets to its governance structure. CAMELS has definitely been an inspiration, with aspects like Asset Quality, Management, and Liquidity (A, M, and L) being particularly relevant.
At the same time, SMIDGE is tailored specifically to address the unique challenges and risks inherent in stablecoins while recognizing the similarities these challenges share with those faced by traditional banks in ensuring the parity of a dollar in a checking account with a physical dollar bill.
Cryptocurrency technology opened new doors for financial innovation; however, making sure that an “inside dollar” retains its equivalent value to an “outside dollar” consistently remains a significant challenge.
Q: Is your framework flexible and open to criticism? If an alternative rating board came along, would you welcome it?
A: Absolutely. We believe in the power of collective wisdom and are open to constructive criticism. We’ve been talking with critics and supporters both before and after our summer 2023 launch. I actually gave a talk this summer at Stable Summit in Paris—The Stablecoin Temptation— mostly telling people how to start their own stablecoin rating agency.
We could use more voices and more ratings. There’s more than one reasonable way to rate bonds, cars, or laptops, and there’s surely more than one reasonable way to rate stablecoins.
Nonprofit Status & Transparent Evaluation
Q: You made Bluechip a nonprofit with no commercial interest for co-founders. Is it a purely altruistic move or the way to ensure you’re unbiased in your stablecoin evaluations? If you rely on donations, will you be able to remain impartial?
A: We know that credibility is crucial to Bluechip’s success, and choosing to set ourselves up as a nonprofit was one part of that process. In addition, nobody at Bluechip holds stablecoin governance tokens, so we have no financial upside if particular coins do well.
We also have a diverse group of donors both inside and outside of the stablecoin ecosystem, and it’s been growing more diverse every month.
Ultimately, our SMIDGE methodology is the real signal that we’re unbiased: We’re grading based on the fixed framework, not making game-day judgment calls.
Anyone can look at SMIDGE and tell that it’s an impartial way to assess coins.
Q: Will your rating help (or force) stablecoins to improve or sink potentially faulty ones?
A: Our aim is to provide a transparent evaluation that can guide both issuers and users. While we don’t have – or want to have – the power to “force” any changes on stablecoin issuers, we believe that a low rating will incentivize issuers to improve their practices.
Coin issuers have been contacting us pre-release to see how they could potentially improve their ratings, and we’re glad to talk to more potential issuers to explain why we think some ways to run a stablecoin are far safer and far more transparent than other approaches.
Features of a Safe Stablecoin
Q: Why did you rate the giant tether (USDT) so low? How did binance USD (BUSD), a stablecoin halted by the New York State Department of Financial Services (NYDFS), get the A ranking, while USDT, the market’s largest stablecoin by market cap, ended up with D?
A: Tether received a low rating in part due to issues with transparency and governance – in our overview at bluechip.org we explain: “USDT is less transparent and has inferior reserves” than some competing stablecoins, and we note that it could help boost its grade by “performing a complete financial audit by an independent auditor.”
Binance USD (ERC-20), despite its New York State legal challenges, still scored high on stability and governance, key components of our SMIDGE framework. If a government regulator, such as the state of New York, deems a coin unsound while Bluechip holds the view that the coin is sound, we will report our own conclusion independently and transparently.
Governments make mistakes all the time when deciding whether a particular medication or financial product is sufficiently safe to allow the public to use it. Bluechip isn’t here to just repeat what a government regulator is saying.
We need multiple opinions about stablecoin safety, and in this respect, NYDFS and Bluechip are just two differing voices on stablecoin safety.
Q: What are the qualities of a safe stablecoin? Does a low rating mean you recommend refraining from using a particular coin and vice versa?
A: A safe stablecoin should have transparent governance, robust backing assets, and strong risk management practices. A low Bluechip rating, like a D or F, is, at minimum, a strong cautionary note. In contrast, a high rating indicates a stablecoin that meets the vast majority of our rigorous criteria.
Personally, I would feel more comfortable using a stablecoin with a high Bluechip rating.
Still, it’s a lot like auto safety – we don’t all want to drive in a huge SUV, even though those are much safer than most small cars, which in turn are vastly safer than motorcycles. Somebody should still be out there riding a motorcycle, despite the risks. It’s a matter of personal judgment.
We just want users to be aware of key risks so they can make their own judgment.
And when considering standards of high stablecoin reliability, we should be thinking about decades, not months or years. MIT’s Rudiger Dornbusch had it right when he wrote about exchange rate crises: “The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought.”
The Future of Stablecoins
A: The high transaction volume indicates that stablecoins are becoming an integral part of the financial landscape. Stablecoins are finding their way into the global payment systems, and unless big nations make full-court presses to weaken their influence, stablecoins will keep growing.
I don’t see a big reason for stables to replace fiat in any country. However, they’ll likely be a complement to fiat in more middle and middle-upper-income economies over the next few years.
PayPal’s embrace of stablecoins in its payments system is just a signal of things to come.