What are Yield-Bearing Stablecoins and How Do They Work?
Explore the dynamic world of yield-bearing stablecoins and discover how these innovative financial instruments combine stability with passive income opportunities in DeFi.
By now we all know the traditional stablecoins that are designed to capture the ‘stability’ of the real dollar and maintain a stable value in the turbulent places we call home. But now with the rise of yield farming opportunities and the expectation that money has to do more for us than just beat inflation, we have come to a very specific new form of crypto: The yield bearing token or asset.
Today we take a look at yield bearing assets - what they are and why these could be interesting to learn more about.
What Are Yield-Bearing Stablecoins?
To start off, we see that yield-bearing stablecoins do more than their stable counterparts - on top of preserving a stable value, they also enable holders to earn passive income.
These assets offer an additional layer of utility - in fact, ‘yield generation’. They are meant to function like a digital version of a bank deposit (with a bank from the far past, that is).
In DeFi we may know of yield bearing assets such as DeFi yield tokens such as aTokens, cTokens, and yTokens, that represent deposited crypto plus accrued rewards from underlying protocols.
How Do Yield-Bearing Stablecoins Work?
If we take a look at how they work, the principle behind yield-bearing stablecoins is relatively straightforward. Most of the time, these coins are often linked to income-producing assets.
An income generated from these assets is then distributed to the holders of the stablecoins, thus increasing their balance incrementally over time, all of which is automated.
For example, yield-bearing stablecoins pegged to fiat earn interest by participating in DeFi protocols or being backed by assets like treasuries.
There are many other strategies that DeFi protocols use for generating the underlying yield. But where does the yield come from? Today it can be generated in different ways; these include:
Traditional Finance Strategies 🏦
- US Treasury Backing: By investing in US Treasury bills, these stablecoins are able to generate a yield, albeit a low one (0-1%). Holders of these stablecoins earn a share of the interest accrued from these government assets, which is typically lower due to the low-risk nature of the investment.
- Real-World Asset Investment: These stablecoins diversify their backing by investing in various real-world assets such as corporate bonds, which traditionally have higher yields than government securities. The yield is generated in a traditional manner through the interest and dividends paid by these real-world assets.
Hans
DeFi Native Strategies 🌐
- Native Protocol Rewards and Incentives: Stablecoins in this category earn yields through native protocol rewards and incentives. They actively participate in the decentralized finance.
- Lending Funds to Borrowers: These stablecoins function by lending out funds to borrowers and the interest paid by borrowers on these loans serves as the primary source of yield for holders of these stablecoins.
- Overcollateralized Lending: This strategy involves lending out funds where the loans are backed by collateral that exceeds the value of the loans, reducing the risk of default. Interest earned from these overcollateralized loans generates the yield.
- Native Protocol Fees or Yield: These stablecoins are meant to earn yields through various fees or yields directly related to native protocols in the DeFi space. The yields depend heavily on the activity levels and health of the underlying DeFi platforms.
Advanced Trading Strategies 🧠
- Delta-Neutral, Basis Trading, Arbitrage, or Carry Strategies: These stablecoins employ more complex trading strategies such as delta-neutral positions, basis trading, arbitrage, and carry trades. Which are all strategies that aim to exploit market inefficiencies or differentials across platforms. These are more experimental projects that focus on these.
Crypto Derivatives 🔢
- Liquid Staking Tokens: These stablecoins are involved with derivatives like liquid staking tokens, allowing participation in staking protocols while maintaining liquidity.
Difference Traditional Yield Bearing Assets from Digital Ones
Traditional yield-bearing assets like bonds and dividend stocks provide contractually defined, predictable yields governed by legal agreements. Income is paid out on fixed schedules in cash and custody requires intermediaries, limiting accessibility.
In contrast, yields from yield bearing assets are encoded in mutable smart contracts, and this makes them more variable based on changing network conditions. On top of this, this yield is often paid in additional tokens rather than cash payouts. Similar to the freedom that comes from crypto, we see similarities with these types of assets.
On the other side, direct individual custody happens via our wallets which provides instant global access and lets us integrate with decentralized finance.
Bitfinity
Yield Rates
But what is most important for anybody in crypto is that the biggest difference is that different lending-based protocols exhibit varying yield rates, generally higher than traditional ones.
Because other strategies are applied, the DeFi protocols attract and maintain bigger user bases. This works both ways - some protocols may offer higher yields, taking more risk in a search for rapid growth, while others might offer more conservative rates aligned with lower risk. But remember to check out our tips on security below...
Top Yield-Bearing Asset Protocols in Crypto
If we take a look at some of the top protocols that offer these relatively new forms of yield bearing assets, we can list the following. Also, these are based on their growth and usage (these are not endorsements, only for informational purposes):
Ethena
Ethena introduces a unique approach to stablecoins with its USDe, which is not backed by traditional fiat currencies but instead by a portfolio of cryptocurrencies like ETH. The stability of USDe is maintained through a strategy known as delta-hedging.
Ondo Finance
Ondo Finance serves as a bridge between traditional finance and decentralized finance by providing access to real-world assets such as U.S. Treasury bonds. Its stablecoin, USDY, uses short-term U.S. Treasury securities.
Sky (MakerDAO)
Sky, developed by MakerDAO, is a leading DeFi platform that allows users to generate DAI, a stablecoin that is overcollateralized with various cryptocurrencies. A notable feature of Sky is the Dai Savings Rate (DSR), which offers DAI holders an opportunity to earn.
Curve Finance
Curve Finance, which is a decentralized exchange, also provides opportunities for stablecoin assets and reward mechanisms. Innovations like CurveUSD and the LLAMMA system enhance its role in stablecoin stability and DeFi liquidity.
Risks of ‘Experimental’ Yield-Bearing Stablecoins
While yield-bearing stablecoins are a dream that is perhaps too good to be true, they are REAL for many. However, it is crucial to understand that these assets come with inherent risks that should be carefully considered.
One of the primary risks associated with yield-bearing stablecoins is the direct correlation between the return on investment and the risk of the underlying assets. In many cases, higher yields are indicative of higher risks.
Another significant risk factor is the potential for smart contract vulnerabilities. DeFi protocols rely heavily on complex smart contracts to automate financial transactions and manage assets. While these contracts are designed to be secure, there is always a risk of bugs, exploits, or unforeseen vulnerabilities that could lead to the loss of funds. Let’s all hold one minute's silence for the recent rug pull of top 100 project Mantra.
Finally, there are still regulatory risks that pose a significant challenge to the yield-bearing stablecoin market. Because the dollar is still dominant (maybe not for long), regulators could boycott many of such initiatives.
Changes in legal frameworks or the introduction of new regulations could affect the legality or functionality of these protocols, potentially disrupting the yield-generating mechanisms or even forcing them to shut down. We never know what is going to happen in the future.
Yield Bearing Asset Protocols That Seek Layer 2 Solutions
There are many protocols that don’t have their own dedicated chain or are searching for places to provide their services. Many of them are actively seeking collaborations with Layer 2 solutions to expand their offerings.
Here comes Bitfintiy, which offers the bridge between Ethereum and Bitcoin where a lot of liquidity is still dormant, waiting to be deployed earning a stable and honest yield.
Fred
The Future of Banking with Stablecoins
Yield-bearing stablecoins aim to address a growing interest in financial instruments that combine stability with potential returns, drawing on established aspects of crypto technology.
As more protocols adopt and develop their versions of yield-bearing stablecoins, we can expect these products to become integral to financial strategies and perhaps go mainstream in a way that our space takes the lead once again.
In 2025, simply offering a stable store of value is no longer enough. Users now expect their assets to work for them where it is not just a bonus but a means to an end.
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