Why 163-year-old ratings firm S&P suddenly decided to rank stablecoin Tether

S&P Global, one of the top three credit rating firms, faulted Tether on Tuesday for a reliance on “riskier assets” backing USDT, its stablecoin.

The firm’s analysts also panned Tether for the “limited transparency” of the entities that serve as its custodians, counterparties, or banks.

By ranking Tether near the bottom of its rating scale, S&P Global underscored longtime criticisms of the most widely held and valuable stablecoin worldwide. Tether’s USDT sports a market capitalisation of $91 billion.

$130 billion market

In a move that may help standardise the $130 billion stablecoin market, S&P Global launched its own batch of stablecoin ratings this week.

The reports have been in the works for a couple of years, said Chuck Mounts, the chief DeFi officer at S&P.

“We engaged with maybe almost 1,000 external stakeholders,” Mounts told DL News. “One consistent thing we heard from that wide range of stakeholders is the fact that there’s a lack of an ability to really understand the risks that are inherent in different kinds of stablecoins.”

In several reports published Tuesday, S&P Global gave US-based stablecoins an edge, citing the low-risk assets backing them. The firm ranked the stablecoins on a scale of one to five, with one being best.

No stablecoin earned S&P’s highest rating. But USDC, GUSD and USDP were each slotted in the firm’s second tier, reserved for stablecoins considered “strong.”

Tether was in the fourth tier, reserved for stablecoins considered “constrained.”

DAI and FRAX

More decentralised alternatives DAI And FRAX also received poor scores: DAI, issued by Maker, was in the fourth tier, while FRAX was in the fifth, which is reserved for stablecoins considered “weak.”

To calculate its ratings, S&P relied largely on the quality of assets backing the stablecoins, their degree of collateralisation, and their liquidation mechanism.

Other factors included token governance, the legal and regulatory framework in which the tokens are issued, plus their redeemability, their liquidity, third-party dependencies, and their track record.

Like Bluechip, a stablecoin-specific ratings nonprofit that launched earlier this year, S&P gave high marks to US-based stablecoins. Circle, Gemini Trust Company and Paxos Trust Co. received the most favourable marks.

Circle’s USDC is backed mostly by low-risk assets: US Treasury bonds and U.S. Treasury repurchase agreements, 95% of which are held in the Circle Reserve Fund at BlackRock, the giant asset management firm.

The remaining 5% are held at unnamed “regulated financial institutions” to “facilitate the USDC issuance and redemptions,” according to its monthly attestation reserve reports, which are reviewed by Deloitte.

Bankruptcy questions

But S&P docked points from USDC over uncertainty as to what might happen in the event Circle files for bankruptcy. Circle claims that USDC reserves would be shielded from the company’s creditors in that event.

But S&P’s analysts aren’t so sure. They said it was unclear whether people who hold USDC would be able to redeem them for dollars if Circle filed for bankruptcy, or whether the assets that back USDC would get tied up in lengthy legal proceedings.

S&P also said USDC’s track record wasn’t perfect. The token briefly slipped from its dollar peg earlier this year when Silicon Valley Bank collapsed.

The bank held more than $3 billion in USDC reserves, and when investors rushed to redeem their USDC the stablecoin fell to as low as 86 cents.

While Gemini’s GUSD also received high marks for the mix of collateral assets and its oversight by New York state’s Department of Financial Services, S&P analysts didn’t like its lack of liquidity on secondary markets.

GUSD has a relatively meagre market capitalisation, much of it locked away as collateral for Maker’s DAI.

Paxos’ USDP also benefitted from a mix of low-risk assets, but was dinged for holding its deposits “at a variety of rated as well as unrated banks.”

Tether gets poor marks

Tether’s USDT received relatively poor marks for its asset mix and lack of transparency.

While low-risk assets make up the majority of Tether’s collateral, some 15% are in “riskier assets,” such as precious metals, secured loans, and “other investments with limited transparency on their composition,” S&P said.

The firm also faulted Tether for not providing a fulsome explanation of the “entities” that serve as the platform’s custodians, counterparties, or banks. It didn’t help that Tether doesn’t answer to any particular regulator.

'We see the lack of regulation and/or supervision of USDT as a weakness.’

—  S&P Global

“This contrasts with some stablecoin issuers that are subject to regulatory oversight by an authority, such as the New York State Department of Financial Services,” S&P said. “We see the lack of regulation and/or supervision of USDT as a weakness.”

As was the case with USDC, the lack of certainty as to what would happen in a bankruptcy was also cause for concern.

Tether did not immediately return a request for comment.

Rune Christensen’s influence

Maker’s DAI was faulted for its reliance on real-world assets.

Although real-world assets have boosted Maker’s profits over the past two years, they also introduce relatively illiquid credit risk and would be difficult to convert to cash in an emergency, according to S&P.

Maker and DAI are governed by a digital cooperative, MakerDAO. This crypto-native governance structure poses its own issues, the ratings firm said.

While DAOs provide transparency regarding on-chain assets and upcoming changes, S&P noted, control of Maker is highly concentrated.

“This is especially true when considering active voters,” the firm wrote. “In particular, co-founder Rune Christensen maintains significant influence in the MakerDAO community.”

Fourth and fifth tiers

FRAX, meanwhile, received poor marks because the collateral backing it is worth less than the amount of the stablecoin in circulation.

While most of the collateral is in stablecoins and other cryptocurrencies, some comes in the form of FXS, a sister token.

True USD and First Digital USD were slotted in the fifth and fourth tiers, respectively, due to limited information regarding the creditworthiness of institutions holding their collateral.”

True USD was also dinged for a lack of information “on the nature of the assets in the reserve.”

What comes next

Charles Jansen, the head of DeFi Transformation at S&P, said the collapse of Terra’s UST stablecoin in May 2022 put a spotlight on the need for a framework others can use to gauge major stablecoins.

Some risk assessment startups at the time “had UST as their number one safest coin,” he said. “Well, some just disappeared, some renamed, and some just deleted that from their database.”

Jansen said the firm would consider analysing other stablecoins in the future, including decentralised stablecoins and those issued by banks. Mounts agreed.

“This is our starting point,” Mounts said. “This is not the endpoint.”

Aleks Gilbert is DL News’ New York correspondent. Have a tip about DeFi or stablecoins? Contact the author at aleks@dlnews.com.