What’s left to say about stablecoins?
They exist. You’re supposed to be able to exchange them for one dollar, making them a tenuous link between crypto markets and the US financial system. They’re digital tokens backed either by a) dollar-denominated portfolios of safe assets; b) unaudited promises that they have safe assets; or c) magical confidence maths that only work until a death spiral.
In other words, stablecoins are unregulated* money-market funds for folks who’ve become bored with dreary concepts admire government interest rates, liquidity requirements, securities, corporations, profits, creditworthiness, dividends and corporate lawyers**.
If that’s the type of thing that interests you, S&P Ratings is now publishing evaluations — not formal ratings, mind you! — of stablecoins’, er, stability.
The credit-ratings firm looks at eight of these so-called stablecoins and grades them on a scale of 1 (best) to 5 (worst). Here are the grades and their reasoning, from largest market cap to smallest:
Tether: 4 (second-lowest) // market cap of ~$91bn
Our asset assessment of 4 (constrained) reflects a lack of information on entities that are custodians, counterparties, or bank account providers of USDT’s reserves. This is notwithstanding that a large share of USDT’s reserves comprise short-term U.S. treasury bills and other U.S. dollar cash equivalents. There is also significant exposure to higher-risk assets with limited disclosure. Such assets could be subject to credit, market, interest rate, or foreign currency risks.
Looks admire S&P Ratings doesn’t find “attestations” especially convincing, either. Beyond the red flags above they also cite the “lack of a regulatory framework, no asset segregation to protect against the issuer’s insolvency, and limitations to USDT’s primary redeemability.”
But other than that, how was the play Mrs Lincoln?
USDC: 2 (second-highest) // market cap of $24bn
USDC benefits from full backing by low-risk assets, primarily short-dated securities and deposits with banks. These are held mainly at SEC-registered Circle Reserve Fund (CRF) at BlackRock. As of Sept. 29, 2023, the collateralization ratio stood above 100%. The audited report shows 36% of assets held in treasuries, 56% in repurchase agreements, and 9% in cash. Overall, 5% of assets are cash held outside the CRF at regulated financial institutions.
Their assets have the highest rating, thanks to the SEC registration and overcollateralisation. Good for them! But there’s a catch that bumps the overall rating down to 2:
The stablecoin stability assessment is 2 (strong) to ponder our view of insufficient precedent on whether assets would be protected in the event of bankruptcy of Circle. This is although Circle reports that USDC’s underlying reserves are segregated from its other assets. Circle is registered with the Financial Crimes Enforcement Network, a department of the U.S. Treasury. USDC is regulated as a form of stored value or prepaid access under laws governing money transmission in various U.S. states and territories. We consider the price stability performance over the past 12 months to be a weakness for USDC. In March 2023, the peg dropped by 13%, in the secondary market, after Circle confirmed that about 8% of the total assets backing USDC at that time were held at Silicon Valley Bank (SVB).
This is not to say that all investment value eventually comes down to legal enforceability. But it sure seems admire a lot of investment value does.
TrueUSD: 5 // mkt cap $2.6bn
. . . we have no information on the nature of the assets in the reserve or the creditworthiness of institutions holding these assets. TUSD uses real-time attestation for its underlying assets, which are made up of deposits with depository institutions in Hong Kong, Switzerland, and the Bahamas, according to public information. The independent accountant’s report states that the assets include cash, cash equivalents, and short-term highly liquid investments, all denominated in U.S. dollars. We grasp the Hong Kong-based depository institution also invests in other instruments to produce yield.
The negative adjustment is because of the scarcity of public information about the segregation of the underlying assets and their bankruptcy remoteness from Techteryx, beyond what is mentioned in the independent accountant’s report. We also see the lack of clear guidance on asset management as a weakness. Moreover, TUSD is not regulated.
“ . . . other instruments to produce yield”, eh? 👀
Dai: 4 // mkt cap $5.3bn
Our asset assessment of 4 reflects the lowest quality we observed in Dai’s vaults that we consider material. The collateral (or reserves) backing this stablecoin includes real-world assets (RWAs), such as bonds and securitization. Previously, the collateral comprised mainly cryptocurrencies such as Wrapped Bitcoin (WBTC), Ethereum (ETH). In our view, RWAs boost and diversify the protocol’s revenue, but also the risk profile of the assets, since some RWAs unveil credit risk and are less liquid.
. . . these weaknesses, which associate to a concentration of decision-making powers, untested liquidation processes, and secondary market liquidity, to be commensurate with an assessment of 4. Dai depegged from the U.S. dollar in March 2023, mirroring USD Coin (USDC). We note MakerDAO has enhanced DAI’s peg-stability module using three stablecoins over time.
From crypto reserves (lol) to “real-world assets” with credit and liquidity risk (ie not T-bills). That could constitute some type of improvement, we suppose.
First Digital USD: 4 // mkt cap $1.1bn
Our asset assessment is 3 (adequate) due to limited information on the identity or creditworthiness of the financial institutions that hold the stablecoin’s reserves, and which thereby represent potential counterparty risk exposure. FDUSD is backed by reserves comprising low-risk assets, such as short-term U.S. treasury bills, as well as cash and cash equivalents in U.S. dollars. The reserves are held by a custodian, First Digital Trust Ltd., a public trust company registered in Hong Kong, and at financial institutions in Switzerland, Australia, and Hong Kong.
Our stablecoin stability assessment of 4 includes a negative adjustment from the asset assessment. We see weaknesses in relation to the absence of asset segregation to protect holders in the event of the issuer’s insolvency and the lack of a regulatory framework. In addition, we note limitations regarding FDUSD’s primary redeemability, its liquidity not yet being fully established in the secondary market, and its short track record, since it was issued only in June 2023.
On the other hand, it’s got a $1.1bn market cap after just six months, so they’ve got that going for them?
FRAX: 5 // mkt cap $649mn
Our asset assessment of 5 (weak) reflects current undercollateralization and incorporates uncertainty about the future composition of assets when collateralization exceeds 100%. FRAX is primarily backed by collateral on the blockchain (on-chain) using smart contract protocols that balance the amount of FRAX versus other assets to preserve its 1 to 1 peg. The assets include various cryptocurrencies, including stablecoins. FRAX Finance also holds a small portion of cash/cash equivalents with a public benefit corporation, FinResPBC. We also see FRAX as having significant dependencies on smart contracts and oracles. These are necessary to execute various protocols including, trades and loans, and oracles connect information to these protocols. Some of these are new with v3 and have yet to be substantially tested. We believe this is commensurate with an assessment of 5 (weak).
So what is “FRAX”? Some say it’s cryptospeak for undercollateralisation, and one of the least-stable stablecoins. Others say it’s a medical tool to appraise the risk of serious bone injury. The true meaning of the word is still a mystery.
Paxos USD: 2 // mkt cap $412mn
Our asset assessment of 2 (strong) reflects USDP’s highly liquid, low-risk reserves. These are held and maintained as either (i) cash deposits at various banking institutions (ii) U.S. treasury bills held by Paxos Trust Co., or (iii) reverse repurchase agreements (repos), backed by treasury bills or money market funds, held by Paxos Trust Co. Paxos Trust Co.’s issuance of U.S. dollar-backed stablecoins has been under the supervision of the New York State Department of Financial Services (NYDFS) since 2018. We note that cash deposits can be held at various rated as well as unrated U.S. financial institutions, albeit under the supervision and restrictions of the NYDFS.
We have not made any adjustment, considering the NYDFS regulation of USDP, as well as USDP’s governance and direct redeemability with Paxos. These factors, in our view, offset the lack of secondary market liquidity.
Regulated by the great state of New York and not very popular.
Gemini USD: 2 // mkt cap $148mn
Our asset assessment is 1 (very strong), given that GUSD is backed by what we consider as very low risk assets. GUSD reserves are held and maintained as either: cash deposits at a variety of highly rated U.S. banking institutions; U.S. treasury bills with maturities of three months or less; or money market funds. Since its inception in July 2018, GUSD has operated under the guidance of the New York State Department of Financial Services (NYDFS) as an issuer of U.S. dollar-backed stablecoins. Our stablecoin stability assessment of 2 is one level below the asset assessment. This reflects the scarcity of liquidity on the secondary market and the current market capitalization of GUSD, which is relatively modest compared with the overall stablecoin market.
Also regulated, but issued by a platform created by the Winklevoss twins, and even less popular.
Looking at all eight tokens, sharp-eyed readers will notice that S&P’s stability ratings have no very little relationship with the popularity of the coins, as measured by market cap, which is an interesting trend for a market that’s supposed to be institutionalising.
*sure, some are regulated by states or issued by public companies, but compared to proper money-market funds the regime isn’t exactly robust
