Home / Crypto News / News / Stablecoins and Ratings Agency: S&P Reveals Critical Flaws
6 min read

Stablecoins and Ratings Agency: S&P Reveals Critical Flaws

Last Updated January 17, 2024 11:15 AM
Giuseppe Ciccomascolo
Last Updated January 17, 2024 11:15 AM
Key Takeaways
  • Stablecoins are playing an increasingly important role in the cryptocurrency ecosystem.
  • S&P found that many stablecoins are not backed by enough reserves to maintain their peg to fiat currencies.
  • Tether, the largest stablecoin by market capitalization, received a rating of 4 from S&P, indicating that it is a “constrained” investment.
  • The approval of a Bitcoin ETF may attract some investors away from stablecoins.

In the cryptocurrency universe, stablecoins are carving out an increasingly significant role. These tokens aim to reproduce and maintain in a digital key – and within a blockchain – the value of traditional currencies, such as the US dollar and euro or, in some cases, commodities like gold.

Anyway, a recent report from the rating agency Standard & Poor’s (S&P) highlighted that the majority of these tokens lack the necessary backing to maintain their peg to fiat currencies. The report, which scrutinizes the top 12 stablecoins, raises serious concerns about the transparency and integrity of the stablecoin market, potentially jeopardizing investor confidence and fueling fears of a potential meltdown.

Stablecoins’ Role

At this pivotal juncture, stablecoins primarily address two key use cases: firstly, they provide crypto-investors an avenue to mitigate the volatility inherent in Bitcoin and other cryptocurrencies, enabling them to stay within the realm of digital wallets. For instance, they facilitate the conversion of Bitcoin into digital dollars, allowing investors to navigate periods of heightened price fluctuations.

The second main application revolves around financial inclusion. Many countries grapple with the dual challenge of a lack of access to traditional banking services and existing in an economic landscape marred by high inflation.

In nations grappling with high inflation, the growing adoption of stablecoins stems from the capacity to convert volatile local currencies into stable alternatives like the dollar and euro. This trend is evident in countries such as Lebanon, Turkey, Argentina, and Venezuela. In these places, inflation reaches double, if not triple, digits.

However, a crucial question arises: are stablecoins genuinely “stable” and do they possess the attributes necessary to safeguard investors? Historical incidents suggest otherwise. In May 2022, the UST stablecoin of the Terra/Luna protocol experienced a sudden failure, resulting in a substantial billion-dollar loss for numerous crypto-investors who had placed their bets on this alternative form of the “digital dollar.”

S&P Examination

S&P Global Ratings, renowned for its pivotal role in downgrading the U.S. sovereign debt from AAA in 2011, has recently delved into the realm of stablecoins. The agency has introduced the “Stablecoin Sustainability Assessment (SSA) .” It is a comprehensive evaluation aimed at gauging a stablecoin’s capacity to uphold a steady value compared to traditional fiat currencies. The assessment encompasses evaluations of eight major stablecoins: DAI, FDUSD, FRAX, GUSD, USDP, USDT, TUSD, and USDC.

The rating scale ranges from 1 (“very strong”) to 5 (“weak”) based on the stablecoin’s proficiency in maintaining its peg to a fiat currency.

Why did S&P Global Ratings venture into the stablecoin evaluation arena? Lapo Guadagnuolo, Head of the Center of Excellence Methodologies at S&P, sheds light on the motivation: “As a rating company, we are consistently intrigued by developments in the financial landscape. We strive to comprehend new technologies and articulate our perspective on the risks and opportunities these innovations bring.”

For the past two years, S&P’s interest has been deeply rooted in the realm of decentralized finance (DeFi). And stablecoins undoubtedly constitute a pivotal element within the DeFi domain.

Guadagnuolo said: “They serve as a crucial bridge between traditional and decentralized finance. From an S&P standpoint, delving into their study allows the agency to offer investors insights into which stablecoins are deemed the most reliable.”

Rating Agency’s Concerns

What are the key findings from S&P’s research? Guadagnuolo said: “None of the eight stablecoins analyzed managed to achieve a perfect score, securing the highest rating of 1. Three earned a rating of 2, denoting strength. But Tether’s USDT, with a market share exceeding 70%, received a rating of 4, indicating a constrained category.”

When it came to what factors contributed to this assessment, Guadagnuolo explained: “Our evaluation is based on a combination of factors. Notably, Tether’s reserves supporting its value allocate a significant 10-15% to higher-risk investments, a proportion we consider substantial.”

Unlike most stablecoins that invest in short-term US Treasury bonds, Tether‘s investment composition is a concern. Additionally, there is a lack of transparency regarding the counterparties serving as custodians for these reserves.

Furthermore, there is ambiguity about the location of these reserves and the deposition of the associated cash. Lastly, there is a notable lack of clarity regarding the fate of the reserves in the event of the sponsor’s bankruptcy.

Which stablecoins stood out as the best performers?

The S&P manager said: “Three stablecoins received a rating of ‘2’: USDC, sponsored by Circle; GUSD, sponsored by Gemini; and USDP, sponsored by Paxos. These stablecoins exhibit greater transparency regarding asset investment. And two of them adhere to robust regulations, aligning with New York State law. This legal framework mandates specific characteristics of clarity and transparency concerning the assets held.”

Will Bitcoin ETF Approval Render Stablecoins Obsolete?

The advent of a Bitcoin ETF may indeed attract increased interest from other investors in Bitcoin. However, Bitcoin will likely remain a volatile asset for an extended period.

Guadagnuolo concluded: “Consequently, I anticipate that stablecoins will continue to be appealing for an extended duration. Their enduring appeal stems from their immunity to the volatility characterizing cryptocurrencies like Bitcoin or traditional currencies found in nations experiencing high inflation. In essence, stablecoins cater to a crucial use case.”

Was this Article helpful? Yes No