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CONTENTS
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CONTACTS
Tom Lombardi, Head of Product
Christine Cai, FRM, Director of Business
Christian Lantzsch, Director of Research
Sefton Kincaid, CFA, Managing Partner
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This document provides a detailed overview of Cicada’s Tokenized Risk Assessment (TRA) methodology for stablecoins, including, fiat backed, crypto backed and algorithmically based stablecoins. This document should serve as a foundation for users of Cicada’s research to glean additional context on Cicada’s risk scoring methodology.
When rating tokenized yield bearing products on blockchain-based platforms, Cicada analyzes the underlying Asset Quality, observing the reserve assets, liquidity, counterparties, leverage and base currency instruments, collateral, and historical performance data. We also examine issuer and Operational Workflow to understand the chain of events to tokenize various financial assets. Next, we analyze Management’s capital and legal structures, transaction documents, and legal opinions to assess the effectiveness of structural enhancements that may support higher or lower ratings in the event of heightened structural dependencies. Lastly, we examine key External Factors of regulation and network adoption and diversification.
All of Cicada’s risk ratings work employs judgement. Our stablecoin risk framework is designed to capture a multitude of asset, operational, counterparty, and market risks into account. While our methodologies are rigorously tested, the unique nature of tokenized asset structuring, supporting collateral, and varying legal systems introduces idiosyncratic risks. In our judgment, these factors may reduce the effectiveness of certain risk mitigations, and we account for this in our ratings process to ensure a more accurate reflection of the risks involved. Consequently, there may be times when certain components are de-emphasized or deemed irrelevant. We invite those with further questions related to our ratings to reach out to members of the Cicada team.
The approach laid out in the following methodology applies to new stablecoin ratings as well as existing ratings we assess on an ongoing basis for our partners. New ratings involve an assessment of both historical performance and forward-looking risk factors while existing ratings are periodically updated based on underlying business, legal, market, or regulatory trends.
This methodology does not include an exhaustive description of all risk factors that our analysts may consider but standardizes the input of key information into a benchmarking process whereby users of our research will have a better understanding of the relative risks across various tokenized product offerings.
The stablecoin TRA begins with a standardized risk framework (as depicted below in Figure 1) predicated on four core pillars of risk specific to stablecoins: Asset Quality, Operational Workflow, External Risk Factors, and Management Policy. We combine the assessment of these risks into a generic ratings output (Cicada’s “TRA Ratings”) that can be standardized across various tokenized product offerings.
Figure 1: Tokenized Risk Assessment Taxonomy
We employ a scorecard system to depict our assessment of bottom-up risk analysis to allow clients of our research a snapshot into key strengths and/or weaknesses. Our methodology utilizes a 1-5 numerical rating scale, with investible ratings falling between 3.0 to 5.0, which can be mapped to traditional probability of default-based risk ratings.
We have witnessed investment analysis and compliance as the most pressing needs for our ratings work, but ratings are designed to be utilized by various user types across any organization integrating digital assets.
Information richness is paramount in any risk assessment and our guiding principle in providing a rating. As such, we focus on downside protection (also known as Expected Loss) analysis across our Stablecoin and Credit frameworks that we expect to reasonably map to long-term rates of expected losses witnessed in traditional assets.
For stablecoin issuers, underlying Asset Quality is the most important pillar in our Methodology due to its direct impact on the stability and overall viability of the stablecoin. In particular, a primary purpose of a stablecoin is to maintain its peg, typically the US dollar. High-quality assets are paramount in achieving a peg, with quality defined from multiple lens. Value preservation is not just a long-term balance sheet analysis, but also a short-term market-based liquidity analysis. High-quality assets are typically, but not always, more liquid, allowing for easier redemptions and maintaining a peg during market stress. Reserve assets must also have strong fundamentals and reduce base currency mismatches at a minimum or have some means to offset these mismatches via overcollateralization. Finally, an analysis of the counterparties that hold and transfer the assets along the tokenization value chain.
Figure 2: Asset Quality Criteria & Weightings
High quality assets play a crucial role in risk mitigation. Among the associated asset quality risks certain stablecoin issues take are credit risk, market risk, counterparty risk, interest rate risk, smart contract risk, and currency risk. The acceptance or explicit reduction of these risks, programmatically or via off-chain legal documentation, Terms and Conditions, or Management Agreements are a key part of our analysis incorporated in Asset Quality but also magnified in our review of Operational Workflow and Management Policies.
We analyze the Asset Quality component holistically, meaning the criteria of Asset Quality are interrelated. An example would be a 100% US Treasury Bill-backed stablecoin vs. a 100% Crypto-backed overcollateralized stablecoin. The degree of collateralization, Quality, and Liquidity are reasonably interdependent factors affecting the asset base supporting instant redeemability of a stablecoin, maintenance of a peg, and ensure long-term viability.
Issuers of stablecoins should specialize in risk transformation by taking either on- or off-chain assets, and responsibly wrapping into a tokenized package that removes barriers and increases utility. A well-designed operating workflow is essential for managing liquidity and handling redemptions to maintain a peg.
Figure 3: Operational Workflow, Criteria & Weightings
Tokenholder Rights are paramount to ensuring legal or algorithmic recourse mechanisms are in place, preserving a peg, and consequently adding user value. We incorporate an analysis of minority tokenholder’s rights to assets under the legal framework or smart contract governing the stablecoin. Next, we map each stage of the stablecoin workflow from purchaser of the tokenized dollars to seller of the underlying treasuries, as an example. A fundamental understanding of the workflow is paramount to understanding legal frameworks and tokenholders rights in the event of conflict or a depegging event.