S&P Flashes A Warning Light For DeFi: Inside Sky’s Credit Rating

S&P Flashes a Warning Light for DeFi

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Wall Street Meets Web3

What happens when Wall Street’s oldest risk models meet the newest form of money? In a landmark first, S&P Global Ratings assigned a credit rating to Sky Protocol, operator of USDS – the fourth-largest stablecoin in circulation and one of DeFi’s systemically important players. The verdict: a speculative-grade “B-” with a Stable outlook, a grade normally reserved for risky corporate debt.

The decision marks a turning point: a traditional credit agency has formally recognized a decentralized protocol while also shining a harsh spotlight on its vulnerabilities. For Sky, and for DeFi as a whole, the message is clear – legacy finance is willing to engage, but only on its own terms.

Adapting S&P’s Legacy Playbook to Decentralized Finance

S&P’s mandate is simple: evaluate the probability of full and timely repayment of liabilities. In Sky’s case, those liabilities are its stablecoins – USDS and its staked version, sUSDS. The credit rating reflects S&P’s view of the risk that these tokens could break their peg or fail to honor redemptions.

Rather than shoehorning Sky into a bank template, S&P adapted its framework for nonbank financial institutions. The result was a “ratings-to-principles” approach: keeping the core pillars of capital, liquidity, asset quality, governance, and regulation, while layering in DeFi-specific realities like DAO voting, on-chain risk controls, and uncertain legal status.

S&P’s five assessment pillars:

1. Capital Adequacy and Earnings – is there a sufficient buffer to absorb losses?
2. Liquidity and Funding – can the protocol meet withdrawals during stress?
3. Asset Quality – what risks are embedded in loans and exposures?
4. Governance and Control – how resilient is the decision-making process?
5. Regulation and Legal Frameworks – is the operating environment predictable and enforceable?

Basel Rules and the Harsh Reality of Risk Weights

At the heart of S&P’s methodology is the Basel framework, the same playbook used to evaluate banks worldwide. Basel requires banks to hold capital equal to at least 8% of their risk-weighted assets (RWA). Crucially, assets are not treated equally: low-risk assets like T-bills receive minimal weights, while riskier instruments receive higher ones.

The treatment of crypto is especially unforgiving. The Basel Committee divides it into two categories:

• Group 1 (low risk): tokenized traditional assets and regulated stablecoins (like USDC).
• Group 2 (high risk): everything else. Within this, Group 2A covers major coins like Bitcoin and Ether with hedging in place, while Group 2B sweeps in all other crypto. Assets in Group 2B receive a staggering 1,250% risk weight.

Sky’s Portfolio Under the Microscope

S&P’s Basel-inspired analysis of Sky’s balance sheet made by DeFi Researcher Asher Aharonov reveals both resilience and fragility. The protocol’s assets are spread across crypto-backed loans (52%), USDC in its Peg Stability Module (24%), tokenized money market funds (12%), and a controversial 11% allocation to USDe, a synthetic dollar, held indirectly through its SubDAO, Spark. Applying risk weights, these positions translate into a total required capital buffer of 14.4%, with USDe alone accounting for over three-quarters of that requirement due to its punitive 1,250% risk weight.

״On the positive side, Sky benefits from meaningful diversification into low-risk assets. Nearly a quarter of reserves are parked in USDC, while another $1 billion sits in tokenized MMFs such as BlackRock’s BUIDL, offering institutional-grade liquidity. Its liquidation engines held firm through the 2022–23 downturn, its cybersecurity defenses are among the strongest in DeFi, and as the issuer of USDS – the fourth-largest stablecoin – Sky occupies a systemically important position in the market”, Aharonov told me in an interview.

“Yet these strengths are overshadowed by structural weaknesses”, Aharonov said, “The protocol’s risk-adjusted capital ratio stands at just 0.4%, far below the 8–10% expected of banks, leaving Sky thinly capitalized. Surplus reserves are limited to $70 million, native tokens (SKY and SPK) are excluded as too correlated with protocol health, and the backstop remains “Debt Auctions” – minting and dumping SKY precisely when confidence would be lowest. The USDe exposure compounds the strain on the protocol’s capital structure, turning what appears to be a modest 11% allocation into a disproportionate burden on risk-weighted capital – a dynamic that is likely to deter institutional investors”.

Governance further amplifies fragility. Low voter participation has left control concentrated with founders and whales, a weakness exposed in a failed governance takeover attempt in February 2025, when the founder was forced to collateralize his own tokens to defend the protocol. Concentration risks loom large: a handful of large depositors could withdraw simultaneously, rapidly draining the Peg Stability Module and triggering liquidity stress. Overlaying all of this is persistent regulatory uncertainty around decentralized stablecoin issuers, limiting institutional adoption and leaving Sky to navigate an unclear legal path.

The result is a protocol with undeniable liquidity and market relevance, but one operating with a razor-thin capital buffer, heavy reliance on a risky derivative-backed asset, and governance vulnerabilities that leave it exposed when stability is most needed.

The Roadmap to a Stronger Rating

S&P’s rating can also be read as a guide. For Sky, the path to a stronger credit profile may depend on how it balances stability with yield. Accoring to Aharonov’s analysis, these could be Sky’s next steps:

Near-Term Possibilities

• Reassess USDe Exposure: Reducing the current 11% allocation to USDe in favor of more capital-efficient assets such as tokenized Treasuries or USDC could significantly ease the capital requirement, even if it means forgoing some yield.
• Formalize Surplus Policy: Introducing a reserve policy that scales automatically with risk-weighted assets and liabilities might help strengthen resilience and build confidence among external observers.

Medium-Term Considerations

• Build the Capital Buffer: Gradually increasing the risk-adjusted capital (RAC) ratio toward 2–3%, and eventually 5%, could signal a more robust safety net and position Sky for a potential upgrade.
• Prioritize Retained Earnings: Instead of buybacks, channeling revenue into reserves might offer a more sustainable way to grow capital over time.
• Enhance Governance: Advancing decentralization through the “Endgame” roadmap, experimenting with measures like minimum holding periods for voting rights, or adding safeguards against capture could all help address governance vulnerabilities.

“These steps highlight a spectrum of strategic choices rather than a single prescribed path. The more Sky moves toward conservative risk management, the closer it may come to bridging the gap between DeFi innovation and mainstream financial acceptance”, Aharonov concluded.

The Bigger Picture for Institutional DeFi

S&P’s “B-” rating of Sky Protocol is about more than one stablecoin issuer – it signals a broader shift in how traditional finance engages with decentralized systems. By applying its credit framework, S&P has effectively created a precedent for other protocols. Stablecoin issuers like Frax and Ethena may soon face similar scrutiny, and for institutions bound by risk benchmarks, ratings like this could become the entry point for participation in DeFi.

The decision also highlights a central paradox. DeFi is built on capital efficiency, minimizing reserves to maximize yield, yet mainstream acceptance demands the opposite – conservative buffers and predictable safeguards. Sky embodies this tension: it is systemically important in DeFi, but systemically fragile by traditional standards.

Ultimately, S&P’s grade is less a verdict than a mirror. It reflects how far decentralized finance has come in creating liquidity, security, and innovation – and how far it still must go in building durable capital structures and resilient governance. Whether Sky chooses to adapt or continue on its current path, the lesson is clear: this is only the beginning of Wall Street’s scrutiny of DeFi.