Stablecoins and Tokenomics
With regulatory scrutiny of stablecoins heating up, Kevin Hamilton and Michael Canale discuss what stablecoins are, why they’re under fire, and how they can transform the way we spend.
Developing a token from the ground up is no simple task. To make it easier to understand, Kevin Hamilton and Michael Canale explain what makes a token viable for investors and businesses.
Transcripts
Stablecoins
[00:00:00] Kevin Hamilton: Welcome to the ThinkSet Podcast. I'm Kevin Hamilton, a managing director with the Global Applied Technology team, here with Michael Canale. Mike, do you want to introduce yourself?
[00:00:11] Michael Canale: Yeah, so, hi. I'm Mike Canale. I am a managing director in our Financial Institution Advisory practice. I lead our fintech and crypto teams from a financial institution's perspective.
[00:00:27] KH: Wonderful. Thank you. And we're going to be talking crypto today. So I also am part of the crypto practice. I do mostly work in the strategy and advisory realm, including tokenomics, which we'll talk about a little today as well.
So today, a couple of different topics that we thought we might talk on. All of them are extremely timely, given that here we are at the end of March, and the US banking system is creaking a little bit, and it’s having some overflow effect into the cryptocurrency space. So, I thought we would talk about stablecoins first: what they are, how they're being impacted by the US banking system, and how that's then overflowing into the crypto space. So, do you want to start with what stablecoins are? Can you tell the audience about that?
[00:01:12] MC: Yeah, so stablecoin are cryptocurrencies whose values are pegged or tied to that of another currency, commodity, or other financial instrument. They're generally aimed to provide an alternative to the high volatility of the most popular cryptocurrencies. So like Bitcoin and Eth[ereum], I'm sure everyone's pretty well aware that the valuations of those things fluctuate up and down on a 24-hour basis.
So stablecoins provide a good alternative to that. It's an easy way to on-ramp fiat into crypto, into a pretty low-volatility coin. Traders use them when they're moving in and out of position, so instead of converting back to fiat, they can move to stable and keep those funds on chain.
A lot of the exchanges and treasuries of different projects are held in stablecoin. It's a great way to get yield in a relatively low-risk, coin versus, you know, other cryptos.
[00:02:16] KH: What are some examples of stablecoin that people might not be aware of, or maybe they've heard some in the recent articles?
[00:02:24] MC: Yeah, so I think, USDC is probably one of the top ones most people have heard of. You also have Tether, and these are coins that are pegged to the US dollar. So when you put a dollar in and you mint a stablecoin, that dollar goes into the treasury, and it's supposed to back your coin one to one. And when that stablecoin is ultimately redeemed, that dollar is then returned.
[00:02:52] KH: Are there any other types of stablecoins that are backed by something other than a dollar?
[00:02:58] MC: There's the commodity stablecoins. There's lots of different examples. I mean, like you and I were talking about yesterday, potentially creating a stablecoin that could be a basket of different currencies, right? So it doesn't always have to be a dollar. I think the most popular ones right now certainly are. But there's many other use cases for them. There are central bank digital currencies as well.
[00:03:25] KH: I think of a couple we've come across along the way as well. There's a stablecoin that's backed by gold. There's stablecoin that are unbacked, but theoretically stable. But I think it's important that everybody knows that there are other stablecoins that essentially buy and sell their treasury that's behind them to try to maintain stability. They have generally not worked very well. There's quite a long history of stablecoins that are algorithmic that have not been particularly stable. And a few of those ended up being massive blowups, like the Terra Luna and the backing there.
You mentioned CDBCs, so central bank digital currencies—why don't we dive into that, and let's talk about where you see those going? Who's further ahead than others as far as countries? What do you know about the CDBCs?
[00:04:13] MC: We'll talk a little bit about what they are first, right? So central bank digital currency. It’s a digital currency issued by a central bank rather than a commercial bank. So the liability would be to the central bank. It's denominated in their currency. Same as the case with bank notes and coins.
The US Federal Reserve has not released one yet. They did release a paper. It was called Money and Payments: The US Dollar in the Age of Digital Transformation, and that paper outlined the potential benefits and risks associated with a CBDC. It didn't give a general policy view or a definitive decision on whether the US would adopt one, but it outlines how they're starting to think about these things.
Mainly the Fed is looking at them as an option, as part of its strategy to promote monetary and financial stability. When a third party is doing it, they have a little bit less control, so a CBDC makes a lot of sense from a control and monetary policy perspective.
[00:05:24] KH: I think that we’d be a little bit remiss not to put forward some of the pluses and minuses of CBDCs. People that are in the crypto space are weary of central bank digital currencies. Unlike fiat—so dollars—there are different aspects that could be deployed by a government for CBDCs. So one that has come up is that they could monitor it more heavily. Blockchain transactions are fully on chain, and they're transparent. You may not know who the person is, but you can see what they're doing. For those that are concerned about privacy and having the government view what you're doing, it is definitely a step toward less confidentiality. Where it gets interesting is when monetary policy can be applied to CBDCs.
So, potentially, if you hold the central bank digital currency in a wallet, it could be that actually a negative interest rate is put on that central bank digital currency holding, which would incent you to trade and buy and sell with it. You know, there are different aspects that step way further than we do with fiat currency, where the government could use additional monetary policy on these CBDCs that, really, they don't have available now. So I don't know if you have any thoughts on that or other things you've heard about, potential opportunities to apply monetary policy to these.
[00:06:43] MC: From a benefits perspective, the Fed views it as an opportunity to provide households and businesses with a really convenient electronic form of central bank money. So the dollar is already digital, right? Like, we all use it; I barely hold any cash in my wallet. But the digital dollar that we use is sitting at a traditional bank.
This would ultimately give the Fed a lot more control, and it would also provide more safety and liquidity for users. You know, it could also support things like faster and cheaper payments, including things like cross-border payments, and we've already seen that with other types of crypto.
It could also potentially expand consumer access to the financial system.
On the risk side, though, there is the potential impact of the financial-sector market structure, the cost and availability of credit, the safety and stability of the financial system. I mean, over the past twelve months, we've seen crypto go through a pretty rough bear market. And that has now started to spill over into the traditional financial system. It's not crypto's fault, but it is one of the triggers that started to destabilize things.
But then going back to your question. Monetary policy: how could it be manipulated? I mean, this is 100 percent about gaining more control over an ecosystem and a use case that's already been proven. So if the Fed moves in, they're going to be able to increase and decrease supply much faster than they can now, right? So their monetary policy would be even more immediate than the moves that they make today with raising interest rates.
[00:08:46] KH: I think it's interesting to see how they would move. And I do think that what’ll be fascinating is where we end up with CDBCs, but we'll see. Luckily, they're taking their time to move into the space.
So I think that might wrap us for this topic. And, you know, we can think about moving on to tokenomics. So thanks, Mike, for talking about stablecoins with me.
[00:09:08] MC: Thanks for having me.
Tokenomics
[00:00:00] Kevin Hamilton: Welcome to the ThinkSet Podcast. I'm Kevin Hamilton, a managing director with the Global Applied Technology team, here with Michael Canale. Mike, do you want to introduce yourself?
[00:00:11] Michael Canale: I'm Mike Canale. I am a managing director in our Financial Institution Advisory practice. So I lead our fintech and crypto advisory teams from a financial institution's perspective, and then I also work very closely with our restructuring team at BRG.
[00:00:27] KH: Great, and Mike and I are both in the cryptocurrency group—cryptocurrency, blockchain, and digital assets for BRG. So, we’re going to talk about tokenomics today—which actually we’re just finishing a project on tokenomics, and I think it's a particularly interesting topic. It's not often in life that you get to design an entire economy.
And so, Mike, you want to just introduce tokenomics to start with? Like, what is it? And we can go from there.
[00:00:55] MC: Yeah, so a big part of a crypto project’s success is directly attributed to its tokenomics. So, you know—and that's a catchall for all of the elements that make a particular cryptocurrency valuable and interesting to the market. That can include everything from like the token supply, how it's issued, what utility it has, the purpose of the coin, et cetera. So, you know, in general for a token to be successful, there has to be a really smart, well-designed incentive structure for investors to buy and hold tokens over the long haul. In general, what you see is that projects that really think through this and have a good strategy and documentation around it are more successful than those that don't build really good ecosystems around their tokens.
[00:01:50] KH: Something you said there is really important, because we've seen this before. You know, there has to be a reason for the token to exist. One of the things we do early on when we're working with a new, digital asset Web 3.0-type company is talk to them about: why does the token exist if they want a token? Um, there was a point in time, when everybody wanted a token. They created tokens just to have them. But there really wasn't a reason for them to exist. And that was, um, something that we've blessedly gotten away from now with these more recent projects. A lot of what we're doing is helping them to design how does the economics of their project work and how does their internal token work.
What are some of the reasons that a project might want a token, Mike? Because not all of them have it, but you know, when they do want to have one, what is the point? Why would you want one?
[00:02:38] MC: Yeah, I mean there's a couple of different reasons to have a token. Maybe it would be good to talk through like what the different types are. So there's means of payments tokens, so those enable users to buy goods and services using the token, right? There are governance tokens. Those allow token holders to participate in network protocol or, you know, overall project governance. So they're voting on things that are directly going to impact the, the strategy and the way things work. There's staking tokens, so that's where holders can stake their coins, take them out of circulation, and they receive financial and other rewards for doing so.
And then there’s security tokens. So those, those grant partial or total ownership of a, a real-world asset. So that can be things like real estate, it can be yard. Um, and why would a project want to have a token? Well, it basically makes things a lot more sticky from a customer perspective, right? Like if you're buying those tokens, staking those tokens, using those tokens to participate in the project, you're more likely to stick around and buy more.
That's essentially what's at the heart of all of this. And then, the value of that token. You know, if it keeps going up, that may attract other interests, it may attract other investors. So there's an incentive for the project to do a really good job on managing things like supply burns, you know, yields, et cetera in order to help drive price.
[00:04:12] KH: No, that's great. I think that we'd probably be remiss without mentioning that this is a very controversial area, obviously with the securities and exchange commission looking at these tokens of whether they actually are securities and Mike and I, neither of us are lawyers.And so this is definitely not legal advice in any way. But, um, I think that it's going to be very interesting how this develops over time, whether some of these tokens are ultimately deemed securities. Whether most of them are deemed securities. Um, that’s, certainly beyond the scope of our conversation today, but I think that that is certainly a consideration that people need to make as they look at these different tokens. So presuming we have a project that wants a token, you know, when it goes right, I think you're spot on. Um, you get really customer stickiness, almost like joining a team, right?
You put on the jersey of the team, you join and you know, you know, you get a hat that says the company name, but you actually have the tokens instead. So, um, it really does drive that, that stickiness. I think you could do pretty clever things with the token. But I think we also have seen occasions where things have gone horribly wrong. Um, so do you want to talk about you know, so what are some of the pitfalls? What can happen when it does not go very well?
[00:05:33] MC: Well, if, if there's not a, a well thought out, well marketed you know, strategy behind a token, just simply putting a token out for the sake of putting a token out, which I think we saw a lot of that over the past year or two leading up to the bear market. Like everybody and their mother was putting a token out and hoping it was going to go to the moon, and they really hadn't thought about like, Hey, why am I doing this? And what's it going to be used for?
From that perspective, it can, you know, alienate people. It can feel a lot like a rug. Why did I put my money in this? Um, there's no value here. It really comes down to understanding like, why are we creating this token? What is the potential market for it? Because there's not necessarily a market for every single type of token. Right. And that's one of the things that we, um, do when we're advising clients is we actually go out and look at the size of the total accessible market and, and figure out like, hey, are these valid assumptions to be putting into a model? There should be a model behind the token. and there's lots of different inputs that go into that.
Having very well thought out assumptions, having really solid mechanics around managing the total circulating supply. How are you going to burn tokens and reduce supply to, to maintain price or if the, you know, team itself, like, I think one of the biggest pitfalls that we've seen is a lot of dev teams award themselves significant amounts of tokens. And in the beginning, you'll see this, you know, nice price appreciation and all of a sudden it drops off a cliff when the market floods with more supply, because they're all dumping it. So there's a lot of pump and dump schemes, games getting played. Then that subsequently makes, um, you know, customers very hesitant to put their money into projects that are, are focused on tokens.
[00:07:31] KH: That's spot on. It's a fascinating topic and I think, you know, one of the things that we’re able to bring to the table as BRG is, we have a lot of economists on staff, and I think that we are bringing economists along in partnership with our quote unquote, Web-3-native people like Mike and myself to help to design these token economies. And I think it, it's really interesting conversations that come to pass, you know, where we find our economists get pretty excited as they get to actually design an entire economy from scratch and how things work.
But, um, you're, you know, spot on. Sometimes you see overly complex tokenomics models where the token's trying to do too many things. Um, and you hit on one of the big ones, where the initial distribution of token, which tends to be one of the riskier parts of a tokenomics or, you know, frankly, a whole project. Um, if it's accrued too much to the, you know, developers and the initial investors. And, you know, then you get weird things that happen if the vesting schedules aren't set up correctly. Um, and so that's all things that, you know, we would work on with our clients. So, you know, how do they, you know, appropriately have vesting schedules so we don't have, you know, massive months of tokens that can dump into the market.
And then what, you know, what is the token used for? And I think that, without naming names, we have a project that, that we're just finishing. Um, it’s particularly interesting. Um, you know, the token can be used for all sorts of different things, um, whether that’s to play a game or to have governance decisions. And so I think we see, you know, tokens that are designed with kind of a hybrid of several of the mechanisms you talked about. They're both governance tokens and they're utility tokens. And, um, you know, potentially there's even models where there's a two-token design. And so, do you want to talk about one token, two-token designs real quick? Introduce people to what that means and why you would want one versus another.
[00:09:20] MC: In the, in the two-token design, you usually see a governance token that's, you know, stripped out from the means of payment or medium of exchange token. And, and I think that makes a lot of sense, right? So the, the two-token model awarding governance to those that are either early investors or, you know, big participants in the ecosystem makes a lot of sense. Tying all of that into a single coin kind of dilutes the value of having a separate governance structure. So the two-token model is pretty common. But it does add some complications to valuing the two separate tokens and then, you know, how they interact together and how they ultimately get used in the ecosystem.
It's extremely important from a strategy perspective to have, like I said earlier, very well-documented purposes for both tokens. And then from a financial modeling perspective, it actually complicates the valuation techniques used because you're now using, you know, different formulas and combining assumptions and building out a much more complex ecosystem. From a documentation and modeling perspective, it definitely requires a different set of expertise to model those two things in conjunction with one another.
[00:10:47] KH: Yeah, two token models are complex, but there, but there's good reasons for, for both two and one token models. From our perspective as we, as we wrap up on tokenomics, it was a very quick spin through of this topic. Um, it gets much deeper. And I think that um, as we look at whether it's a Web-3-native project that's starting from scratch and they don't have a company that's already started and they want to have a token, those are the things that we can help design. How the token interplays with their customers and what their ultimate plans are. And then, projects where it's a company that already exists, and they're transitioning part of their project into a decentralized, autonomous organization, where they're essentially giving over parts of their company to a community that's going to be governed by a token. And those are all things that we have helped on and, and we can continue to help on. Any kind of final partying words for us, Mike?
[00:11:34] MC: I would just add on to what you're saying, you know, building a Tokenomics strategy is a lot like building out a business plan and we do that sort of thing all the time, both with traditional finance businesses and web three. So it's really marrying that combination of expertise together to help our clients, you know, create that strategy to you know, really produce a, a solid tokenomics project.
[00:12:00] KH: Awesome. Well, thanks for your time today. I appreciate it and look forward to talking more about tokenomics with you.
[00:11:25] MC: Me too. Thanks, man.