Stablecoins: meet the new boss, same as the old boss
Prasad Gollakota
How stable is a stablecoin? That is a question that S&P attempts to answer via its Global Ratings’ Stablecoin Stability Assessment, a product designed to quantify a stablecoin’s ability to maintain its peg to a fiat currency. It produces a score from 1, very strong, to 5, weak.
It starts with an asset assessment that looks at the quality of the collateral, including credit, market and custody risks, and whether there is any overcollateralisation and a credible path to liquidate assets quickly.
The stablecoin score is not a credit rating but it behaves like one. In calm markets, the difference between strong and weak can look academic, just as spreads can compress and blur the difference between investment-grade and junk ratings when liquidity is abundant.
It is when conditions turn sour and holders rush for the exits that hidden differences in liquidity, governance, transparency and operational dependency show up as wider spreads in credit markets – or pressure on the peg when it comes to stablecoins. The question is simple: does par hold when everyone tries to redeem at once?
Tether downgraded
Tether is the issuer of USDT, the world’s largest US dollar-linked stablecoin and a key source of liquidity across crypto markets. On November 26 S&P cut Tether’s USDT assessment to 5 (weak), from 4 (constrained). S&P’s USDT score is ultimately an assessment of whether USDT’s reserve mix will hold up when markets turn.
S&P framed the downgrade as a reserve composition and disclosure problem. Tether reports that roughly three-quarters of its total reserves sits in cash equivalents such as Treasury bills, repo and money market funds. But S&P focused on the growing share of higher risk components such as bitcoin and gold, alongside secured loans and other investments. In aggregate, those higher risk assets had risen to about 24% of reserves by the end of September, up from around 17% a year earlier.
It also highlighted that the cushion protecting the peg looked thinner against that risk layer. Bitcoin accounted for about 5.6% while the overcollateralisation margin was about 3.9%, meaning a sharp move in bitcoin could erode the buffer and leave the peg more vulnerable.
S&P’s second concern was transparency, criticising Tether for insufficient disclosure about the creditworthiness of custodians, counterparties and bank account providers, and limited detail on the riskier components of reserves. That matters because opacity can accelerate redemption behaviour when stress hits.
At USDT’s size, a “weak” peg assessment is not just a crypto talking point; it is a question about what gets sold when redemption pressure hits. In normal times, stablecoin issuers can be sizeable buyers in short-term money markets.
But if confidence breaks and holders rush to cash out, the issuer may need to sell those assets quickly to raise cash. Rapid selling can strain the same short-term funding markets that banks and central banks rely on to keep the financial system running smoothly.
Access is not easy
In a crisis, the cleanest collateral is cash held at the central bank itself, and that is precisely what USDT does not have.
Federal Reserve master accounts are held at a Federal Reserve Bank, essentially the Fed’s version of a current account for eligible financial institutions. It gives the holder direct access to the Fed’s payment system and lets them settle using balances held at the Fed. That makes it the closest thing to risk-free settlement and, when confidence hinges on the quality of the underlying collateral, the strongest possible backstop.
That kind of access is exactly what narrow banking tries to package for customers: a place to park money that is as close to the central bank as possible. A narrow bank is a deposit backed only by central bank reserves and very short-dated government paper, designed to meet withdrawals at par on demand. It does not lend. It takes no meaningful balance sheet risk. It is simply a conduit that passes through returns to depositors.
As narrow bank proponents have found out, getting a master account is not easy. The Narrow Bank, for example, was denied a master account in 2024 by the New York Fed, which warned that granting one would pose undue risk to the stability of the US financial system and could adversely affect the Fed’s ability to implement monetary policy, particularly during stress.
The issue is not that narrow banking is risky in itself. The issue is that it can become a magnet for wholesale cash, draining deposits from regular banks, accelerating flight to safety behaviour, and making it harder for central banks to manage interest rates and keep markets stable.
A similar concern sits behind the stablecoin debate. A widely used stablecoin competes, at the margin, with bank deposits as a place to park money. If meaningful volumes move, the banking system’s funding mix changes, which is why the Bank of England has framed systemic stablecoins as a financial stability issue and designed its regime to limit large-scale deposit displacement.
The irony
Put it all together and the story is clearer. Regulators are putting rules around stablecoins because leaving a large, private “monetary promise” outside the system is a risk.
The Bank of England’s approach tries to make the backing simpler and safer by requiring a meaningful chunk to sit as deposits at the central bank. But central banks are also making a second point: access to central bank balances is a privilege that will only be granted if it does not create material knock-on effects for banks, money markets and policy transmission.
This leads to the uncomfortable implication for stablecoins. The strongest design is one backed as close as possible to deposits held at the central bank, with settlement that does not depend on another intermediary. Yet that design is not something a stablecoin issuer can simply choose on its own. It depends on the gatekeepers and sits inside a permissioned ecosystem.
In practice, the stablecoins most capable of scaling into mainstream money will be those issued by banks, or by entities that look and behave like banks, because they are already inside the system.
So the irony is that, although stablecoins were born to route around banks, their safest form is the one that pulls them back into the banking system’s orbit.
Prasad Gollakota is a former FIG banker and co-head of the global capital solutions group at UBS. He was later chief content and operating officer at edtech company xUnlocked and specialises in financial institutions, banking regulation, capital markets and complex capital and funding solutions.