1. Introduction
Stablecoins have long been viewed as a crucial tool against crypto market volatility due to their price anchoring characteristics. However, traditional stablecoins (such as USDT and USDC) provide trading convenience and value stability, yet their limitations in asset appreciation capability have gradually become apparent.
Interest-earning stablecoins, such as BUIDL, USDe, and USD0, are emerging types of stablecoins that are rapidly gaining attention. Unlike traditional stablecoins, interest-earning stablecoins not only maintain relative price stability but also provide additional investment returns to holders through innovative yield models. This characteristic not only meets the market demand for safe assets but also offers investors the possibility of inflation resistance, making them the new favorites among investors in the current market.
This article will start from the definition and operational mechanisms of interest-earning stablecoins, deeply analyze their unique advantages and market demands, and explore the challenges and future development potential they face, providing readers with a comprehensive understanding of interest-earning stablecoins.
2. Overview of interest-earning stablecoins
1. What are interest-earning stablecoins
Interest-earning stablecoins are a type of digital asset that not only possesses value-stability characteristics but can also bring substantial returns to holders. Their core feature lies in their innovative yield models, allowing holders to achieve asset appreciation without requiring excessive active management. This type of stablecoin combines the stability of traditional stablecoins with the return capabilities of investment tools, providing users with a new financial experience.
The characteristics of interest-earning stablecoins mainly include:
Price stability: Pegged to fiat currencies like the U.S. dollar, maintaining a 1:1 exchange rate.
Yield: Providing returns to users by investing in low-risk assets (such as government bonds), staking native tokens, or structured financial strategies.
Liquidity: Maintaining high liquidity, available for trading or redemption at any time.
Interest-earning stablecoins not only expand the boundaries of traditional stablecoins functionally but also provide users with more attractive reasons to hold them through yield capabilities, making them a new choice for investors.
2. Core advantages
(1) Counteracting inflation: In the context of an unstable global economic environment and persistently high inflation levels, the purchasing power of fiat currencies is gradually declining. Interest-earning stablecoins provide an effective means of preserving and increasing value by allocating asset returns, such as interest from short-term government bonds, to investors.
(2) Providing diversified sources of yield: The yield models of interest-earning stablecoins vary by project and include:
Government bond investment returns: Such as BUILD and USD0, obtaining an annualized stable return of around 5% by holding short-term U.S. government bonds.
Structured strategy returns: Such as USDe, which brings investors floating annualized returns of up to 30% through financial derivatives and hedging trades.
Staking rewards: Such as FRAX and eUSD, providing higher annualized returns by utilizing ETH staking or blockchain ecosystem yields.
(3) Enhanced user participation: Through the transparent mechanism of smart contracts, users can clearly understand the sources of yields and directly participate in on-chain governance and ecosystem building. This model reduces centralized operational intervention, providing users with higher security and trust.
3. Representative projects of interest-earning stablecoins
1. USDe
USDe is a new synthetic dollar stablecoin developed by Ethena Labs, designed to provide a decentralized, scalable, and censorship-resistant stablecoin solution.
Operational mechanism: The core mechanism of USDe is maintaining a 1:1 peg to the U.S. dollar through a delta-neutral strategy. For whitelisted users (usually institutions, exchanges, and large holders), they can use crypto assets such as ETH, BTC, USDT, and stETH as collateral to mint USDe. Ethena Labs uses these collateral to open corresponding short perpetual contracts or futures positions to hedge against price fluctuations, ensuring the stability of USDe's value. This strategy allows USDe to achieve stability and scalability without the need for over-collateralization.
Currently, ordinary users cannot directly deposit ETH or BTC to mint USDe; they can purchase USDe using stablecoin assets (such as USDT, USDC, DAI, crvUSD, etc.) to avoid liquidation risks.
The yield of USDe mainly comes from the following two aspects:
Staking yield: When users use liquid staking tokens (such as stETH) as collateral, these tokens generate staking yields, including inflation rewards from the consensus layer, transaction fees from the execution layer, and maximum extractable value (MEV). These yields accumulate over time, enhancing the value of USDe.
Funding rates and basis yield: In the perpetual contract and futures market, traders holding long positions typically need to pay funding rates to traders holding short positions. Additionally, the basis of futures contracts (the difference between futures and spot prices) can also yield returns. Ethena Labs utilizes these mechanisms to provide additional sources of yield for USDe holders.
Staking USDe can yield sUSDe to enjoy staking rewards. The yield of USDe fluctuates according to market volatility and changes in funding rates of hedged positions. It once reached an annualized yield of 80% (APY), and according to data from December 26, the current yield of sUSDe is about 8.64%.
Source: https://app.ethena.fi/dashboards/apy
Additionally, Ethena Labs announced the launch of USDtb on December 16, which provides USDe holders with a tool to 'cope with challenging market conditions.' When market changes occur, Ethena can close the hedged positions behind USDe and reallocate its supporting assets to USDtb to further reduce risk. The reserves of USDtb are supported 90% by BlackRock's BUIDL, with the remaining 10% provided by stablecoins like USDC.
2. USD0
USD0 is a decentralized stablecoin issued by Usual Labs, pegged 1:1 to the U.S. dollar, aimed at providing users with a safe, transparent, and compliant digital dollar alternative.
Operational mechanism: The value of USD0 is backed by a basket of tokenized real-world assets (RWA), primarily including ultra-short-term U.S. government bonds and other high liquidity, low-risk financial instruments. These assets are tokenized through partners (such as Hashnote) and managed and verified on-chain. Users can mint an equivalent USD0 by depositing these tokenized assets, ensuring that each USD0 has real assets backing it.
USD0 itself does not generate direct yields, but users can choose to convert it to USD0++, a liquid staking token (LDT). By holding USD0++, users can earn the following yields:
Base Interest: USD0++ holders are entitled to receive the base yields generated by their collateralized real-world assets, such as interest income from U.S. government bonds. These yields are distributed periodically by the protocol, ensuring that holders receive stable returns.
Protocol growth yield (Alpha Yield): In addition to base yields, USD0++ holders can also participate in governance and decision-making of the Usual protocol by obtaining the governance token $USUAL. As the protocol develops and its adoption increases, the value of $USUAL may rise, providing additional returns for holders.
Currently, the yield rate of USD0++ is as high as 56%. Additionally, holders can also participate in the protocol's growth yield by obtaining the $USUAL token. It is important to note that the staking period for USD0++ is 4 years, and holders should consider the liquidity constraints brought by this long-term lock-up period.
Source: https://usual.money/
3. BUIDL
BlackRock launched its first tokenized fund, named BUIDL (BlackRock USD Institutional Digital Liquidity Fund), on the Ethereum network in March 2024, aimed at providing investors with digital asset investment opportunities linked to the U.S. dollar.
Operational mechanism: The BUIDL fund issues tokenized shares on the Ethereum blockchain, allowing investors to hold and trade fund shares digitally. The fund's assets primarily invest in high liquidity, low-risk financial instruments such as cash, U.S. government bonds, and repurchase agreements, ensuring that each BUIDL token is backed by real assets and striving to maintain a stable value of $1 for each token.
Holders of BUIDL tokens can earn the following yields:
Daily accrued dividends: BUIDL tokens calculate accrued earnings daily and pay them directly to investors' wallets in the form of new tokens each month. This means that investors' earnings will be reflected in the incremental number of BUIDL tokens they hold.
Flexible transfer and custody: Investors can transfer their tokens to other pre-approved investors at any time, providing high liquidity. Additionally, fund participants have flexible custody options, allowing them to choose different ways to hold tokens.
As of December 26, 2024, the total asset value of the BUIDL fund has exceeded $620 million and has expanded to five other blockchains beyond Ethereum, including Polygon, OP Mainnet of Optimism, Avalanche, Arbitrum, and Aptos. Its yield is generally close to that of U.S. short-term government bonds during the same period, approximately 4.5%.
Source: https://app.rwa.xyz/assets/BUIDL
4. USDY
USDY (Ondo U.S. Dollar Yield) is a yield-generating dollar token launched by Ondo Finance, aimed at providing investors with a digital asset linked to the U.S. dollar that generates yield.
Operational mechanism: The value of USDY is backed by high liquidity, low-risk financial instruments such as short-term U.S. government bonds and bank demand deposits. Investors can purchase USDY using stablecoins like USDC, and holding USDY is equivalent to indirectly holding these underlying assets. The yield of USDY is achieved through the interest income of the underlying assets, compounded daily and distributed monthly to holders. It is important to note that USDY is only available to non-U.S. individual and institutional investors, with a 40-day lock-up period after purchase during which it cannot be transferred.
Holders of USDY can earn the following yields:
Yield from underlying assets: The short-term U.S. government bonds and bank deposits represented by USDY generate interest income, which is directly distributed to investors after deducting management fees.
Compounded yield: The yield of USDY is compounded daily and distributed monthly, increasing the value of investors' holdings over time.
As of December 26, 2024, the annualized yield of USDY is approximately 4.65%, with a total asset value exceeding $450 million, supporting multiple blockchain networks including Ethereum, Solana, Mantle, Noble, Sui, Arbitrum, and more.
Source: https://app.rwa.xyz/assets/USDY
5. FRAX
FRAX is an innovative stablecoin that belongs to the Frax Finance protocol, maintaining a 1:1 peg to the U.S. dollar through a combination of partial collateralization and algorithmic mechanisms.
Operating mechanism: FRAX adopts a mixed mechanism of fractional reserve and algorithmic stability. Specifically, minting each FRAX stablecoin requires a certain proportion of collateral (such as USDC) and governance tokens (FXS). For example, when the collateral ratio (CR) is 90%, minting one FRAX requires 0.9 USDC and 0.1 FXS. When market demand increases, the system mints more FRAX to meet the demand; conversely, when demand decreases, the system reduces the supply of FRAX. This dynamic adjustment mechanism helps maintain FRAX's peg to the U.S. dollar.
Frax Finance introduced Algorithmic Market Operation Controllers (AMOs), allowing the monetary policy of FRAX to be managed through open market operations rather than just relying on collateral. This flexibility enables FRAX to respond more effectively to market fluctuations.
Holders of FRAX can earn yields in the following ways:
Interest income: Users can earn interest by staking USDC or FXS. The staked assets will be used to support the liquidity and stability of FRAX while providing users with corresponding yields.
Liquidity mining: Users can earn additional rewards by providing liquidity (such as providing liquidity for FRAX in decentralized exchanges). These rewards are typically distributed in the form of FXS or other tokens.
Governance token FXS: Users holding FXS can participate in protocol governance and earn yields through minting taxes, minting/redeeming fees, etc. Additionally, the value of FXS may increase with the success of the protocol, providing holders with opportunities for capital appreciation.
As of December 26, 2024, the annualized yield of USDY is approximately 10%, with a market capitalization exceeding $646 million.
Source: https://facts.frax.finance/
Recently, Securitize Markets submitted a governance proposal to Frax Finance, suggesting that BlackRock's BUIDL token be included as a reserve asset for the FRAX stablecoin. By cooperating with BlackRock, the proposal aims to significantly reduce the counterparty risk of its reserves. If approved, FRAX will adopt the BUIDL token as a supporting asset, similar to Ethena's USDtb.
4. Development potential of interest-earning stablecoins
1. Market environment driving factors
In recent years, the global economy has continued to face high uncertainty, with multiple factors such as inflation, geopolitical conflicts, and monetary policy adjustments driving up investor demand for stable assets.
(1) Pressure from inflation: With global inflation rates remaining high, the actual purchasing power of fiat currencies is declining. Interest-earning stablecoins provide investors with effective inflation hedges through government bond yields or staking returns.
(2) Market volatility and risk aversion demand: The stock market and crypto market are highly volatile, leading funds to flow into lower-risk assets. Stablecoins serve as a hedging tool, providing value stability, while interest-earning stablecoins further enhance attractiveness.
(3) Changes in interest rate environments: As the Federal Reserve raises interest rates, the yields of low-risk assets (such as short-term government bonds) increase, providing stable sources of yield for interest-earning stablecoins. This yield model attracts more institutional and individual investors seeking stable returns.
2. Core needs of investors
The rise of interest-earning stablecoins stems not only from changes in the market environment but also from their ability to meet the needs of multi-layered investors.
(1) High security: The reserve assets of interest-earning stablecoins are mostly short-term government bonds or high-quality crypto assets, which meet the needs of risk-averse investors due to their low-risk characteristics. Compared to traditional bank deposits, interest-earning stablecoins avoid the liquidity and credit risks of commercial banks.
(2) Yield: Compared to the 'zero yield' of traditional stablecoins, the annualized return rate (5%-30%) of interest-earning stablecoins is highly attractive. This yield not only attracts individual investors but also draws in institutional funds.
(3) Diverse application scenarios: Interest-earning stablecoins can be used in various scenarios such as DeFi lending, liquidity provision, and cross-border payments, providing investors with flexible asset allocation choices. For example, users can participate in higher-yield investment opportunities after converting staked USD0 to USD0++.
3. Industry trends
As investor demand continues to evolve, interest-earning stablecoins are becoming the innovative engine of the entire crypto market.
(1) Rapid growth of market size: According to the latest data, the total market capitalization of interest-earning stablecoins has surpassed $200 billion and continues to grow. Emerging stablecoin projects such as USDe and USD0 are attracting significant inflows, indicating a rapidly increasing demand for high-yield stablecoins.
(2) Diversification of product types: The types of interest-earning stablecoins are continually expanding, moving from a single yield model (such as government bonds) to various yield models (such as staking and structured strategies). For instance, USDe stands out with its flexible structured financial strategies, while USDY focuses on the low-risk government bond yield market.
(3) Integration with traditional finance: Traditional financial institutions are gradually entering the field of interest-earning stablecoins, with the BlackRock-supported BUIDL fund becoming a significant participant in this field. This integration not only enhances the legitimacy of interest-earning stablecoins but also brings more institutional users.
5. Potential risks and challenges of interest-earning stablecoins
1. Sustainability of yields
The appeal of interest-earning stablecoins lies in their yield potential, but this characteristic may also be constrained by multiple external factors.
(1) Yield models rely on external markets: A decline in government bond interest rates may weaken the attractiveness of interest-earning stablecoins based on government bond returns.
(2) Uncertainty in the crypto market: The yields of stablecoins based on staked crypto assets are closely related to price fluctuations in the crypto market. Severe market volatility may make it difficult for staking yields to cover risks.
(3) Intensifying competition leading to yield races: With the increase in varieties of interest-earning stablecoins and intensifying competition, different projects can only attract more users by raising yield rates, leading to yield races. However, high yields imply high risks, and balancing sustained high yields with safety becomes a dilemma faced by projects.
(4) Intervention of macroeconomic policies: Changes in central bank monetary policy, such as interest rate hikes or cuts, directly affect government bond yields, thereby altering the yield levels of interest-earning stablecoins based on government bond investments. In a rapidly changing global financial environment, the sustainability of yield models may face challenges.
2. Lack of liquidity and use cases
There is a trade-off between high yields and liquidity for interest-earning stablecoins, which may limit their application and growth.
(1) Liquidity risk: Interest-earning stablecoins typically require locking up assets to earn yields, which may lead to insufficient liquidity, especially during heightened market volatility when redemption demands surge, potentially triggering liquidity crises. Some protocols employ complex staking mechanisms, which may further reduce the liquidity of users' funds.
(2) Limitations of use cases: Compared to traditional stablecoins, the application scenarios of interest-earning stablecoins are still not extensive, mainly focusing on asset appreciation. In scenarios requiring high liquidity, such as payments and trade settlements, interest-earning stablecoins may struggle to compete with traditional stablecoins.
3. Technical and contract risks
Interest-earning stablecoins rely on smart contracts and blockchain technology, which bring transparency and efficiency but also introduce technical risks.
(1) Smart contract vulnerabilities: Flaws in smart contract code may lead to protocol hacks, resulting in capital losses. Although many interest-earning stablecoin protocols have undergone audits, contract risks always exist, especially in complex yield mechanisms.
(2) Black swan events: Technical failures, blockchain network congestion, or external attacks may temporarily interrupt the redemption function of interest-earning stablecoins. For example, during spikes in on-chain transaction volumes or issues with cross-chain bridges, users may be unable to access liquidity promptly.
(3) Inadequate risk management: Some projects may overlook risk management measures during rapid expansion, such as failing to establish sufficient insurance funds or effectively manage reserve assets. This situation could lead to stablecoins losing their pegged value during market turbulence.
4. Regulatory and compliance pressures
Interest-earning stablecoins, as an innovative financial tool, are receiving high attention from global regulatory agencies.
(1) Global regulatory trends: Governments around the world are strengthening regulations on stablecoins. For example, the EU's MiCA regulation and the U.S. stablecoin legislative draft raise higher requirements for reserve assets, transparency, and compliance. Regulatory bodies may pay special attention to the yield distribution models of interest-earning stablecoins to ensure compliance with financial regulations.
(2) Conflict between decentralization and compliance: The decentralized characteristics of interest-earning stablecoins may conflict with compliance requirements (such as KYC/AML), potentially limiting their market expansion. For example, some projects may need to relinquish certain decentralization features to meet regulatory requirements, which would weaken their core competitiveness.
(3) Increased operational costs: To meet regulatory requirements, interest-earning stablecoin projects may need to allocate more resources for compliance audits, transparency disclosures, etc., which could raise operational costs and lower investment returns.
6. Conclusion and Outlook
The rise of interest-earning stablecoins has not only changed the landscape of the stablecoin sector but also injected new vitality into the cryptocurrency field. As a type of asset that combines stability and yield, interest-earning stablecoins successfully integrate the stability of traditional stablecoins with the appreciation capability of innovative financial tools, providing investors with a new asset choice and becoming an essential part of the crypto market, gradually attracting attention from the traditional finance sector.
Looking ahead, interest-earning stablecoins may occupy a significant share of the stablecoin market, becoming mainstream financial instruments. Expanding from asset appreciation to more application scenarios such as payments, insurance, and savings, they could become a new type of reserve asset in the digital economy era, driving the global financial system toward a more open, transparent, and efficient direction.
