Stablecoin yields have quickly become a topic of tremendous interest for both professional investors and retail users. Due to the fact that stablecoins like Tether tokens (USD₮) are in high demand,, it’s important for investors to understand how these yields are generated.

Almost all stablecoins currently are in demand meaning that there are a variety of options available to earn yields. As the industry leader, USD₮ is commonly among the most sought-after stablecoins.

The yields are generated via lending and borrowing activities where the holder of a stablecoin like USD₮ lends out their stablecoin to earn rewards or interest for making their stablecoins available. The process can take place in a wide variety of ways.

Users can earn yield by:

• Providing liquidity to Automated Market Maker (AMM) platforms – i.e: Uniswap, SushiSwap, JustSwap, Serum and Curve

• Making their stablecoins like USD₮ available to borrowers via De-Fi platforms – e.g: Curve or Compound

• Depositing stablecoins like USD₮ with centralized borrowers 

• Engaging in peer-to-peer lending of stablecoins like USD₮ via centralized exchanges – e.g.: Bitfinex

To provide a better understanding of where the yield comes from, this article will explore how yield is generated on these platforms and why there is such strong demand to borrow stablecoins like USD₮.

Liquidity Provision via Automated Market Maker (AMM)

Providing USD₮ liquidity for AMM type exchanges is one of the only ways to earn interest on stablecoins that does not involve lending out stablecoins to borrowers.

Notably, AMM’s require that a user post equivalent amounts of two assets, for example not just USD₮, which facilitates other users to swap between both of those assets. In exchange for their capital, liquidity providers earn a percentage of all fees that the platform generates. However, they will still be exposed to price fluctuations (if any) in the assets they provide.

The yield that liquidity providers generate is extremely variable and dependent on the total trading volume. If trading volume falls, the yield of liquidity providers falls with it.

However, USD₮ is one of the most popular assets to swap with because it offers holders a stable digital asset they can swap in and out of. This popularity means that trading volumes of USD₮ pairs are often much higher than those of other assets.

Lending via De-Fi

A variety of De-Fi platforms provide the ability for any holder to borrow digital assets directly from a Dapp. While there are numerous variations of this service, in essence, users of such apps usually pay a fee in order to borrow assets for a period of time.

Some platforms allow funds to be borrowed without posting collateral (flash loans), but these must be paid back within the same block and cannot be borrowed for longer time periods. However, most require the borrower to post capital which can be liquidated if the value of deposited assets falls too low in comparison to the amount which has been borrowed.

De-Fi lending rates vary from moment to moment based on supply and demand.

Due to the high demand for USD₮, the rates for lending USD₮ are usually much higher than other assets and at times reach annualized yields in excess of 10%.

Lending to a Centralized Lender

Holders can also lend out digital assets to a centralized borrower that earns returns such as by lending those digital assets to other businesses or deploying them in De-Fi.

Centralized lenders act as an intermediary in this situation. If enough of their borrowers defaulted on their loans, it is possible that depositors could suffer a loss.

Unlike De-Fi, centralized lender’s interest rates do not vary on a day-to-day basis in response to supply and demand. Rates are typically fixed for a moderate period of time until they are adjusted up or down due to market conditions.

Lending via Centralized Exchanges

Some centralized exchanges also offer users the ability to earn interest by lending out their digital assets to traders. Traders who want access to leverage are willing to pay a fee for the privilege to access additional capital.

These exchanges allow depositors to agree upon an interest rate with borrowers for their stablecoins such as to provide those borrowers with access to leverage.

The risk for the lender is entirely based on how well the exchange manages the borrower’s collateral, leverage, and if necessary, the liquidation process.

It’s important to understand that many of these use cases are only possible due to the digital nature of stablecoins which empower all of these applications. These applications are able to generate yields that are much higher than traditional savings accounts due to the efficiency with which they can be transacted and borrowed. It is not possible for these applications to be replicated in an efficient way using the traditional fiat payment systems.

The combination of strong demand for stablecoins coupled with the efficiency of digital payment rails is one of the main reasons yields for stablecoin lending are so high.

As the demand for stablecoin borrowing is the main reason users can earn yield, it is also important to understand why traders are borrowing stablecoins.

All three major lending methods are primarily driven by users seeking access to leverage. There are two main uses for this leverage.

The first is when a user wants to gain additional market exposure on top of assets which they already own and do not plan to sell in the short term. Users can borrow against the value of their digital asset holdings and use the borrowed funds to buy additional assets. Borrowing stablecoins against their existing holdings provides the user with the ability to gain greater market exposure.

The second main use is to perform a trade which captures yields that are present in the prices of derivatives contracts. This is typically known as a cash and carry trade.

Most cryptocurrency exchanges offer futures contracts for major digital assets. These contracts have a specific expiration date at some point in the future (1 month, 3 months, 6 months, etc). It is common that these contracts will trade for a higher value than the current price of the asset they represent.

When this occurs, traders can purchase the underlying asset while selling the futures contract short. By doing so, when the expiration date arrives, they are able to earn a profit of whatever premium the futures contract was trading at when the trade was initiated. For example, if a Bitcoin futures contract that expires in 3 months is trading at a 15% premium, a trader who successfully executed this trade could earn 15% after 3 months.

This trade is risk-free on a technical level and is highly sought after when the premium is high.

As most exchanges price their futures contracts in stablecoins (e.g., BTC/USD₮, ETH/USD₮, etc), traders specifically need to borrow stablecoins to perform the trade.

By understanding how stablecoin yields are generated and the specific risks involved with each method, users can make appropriate and risk-informed decisions in terms of earning yield on their assets.

This is particularly helpful for financial professionals who may be skeptical of how it is possible to earn such a high yield on what is essentially cash. Stablecoin yields are solely possible due to the unique properties of a digital bearer asset (settlement finality via an open network) and the applications that have been built using these assets.

USD₮ is the industry leader and the first mover in the stablecoin sector. Tether Operations Limited and its affiliates (“Tether”) pioneered the first asset-backed stablecoin, a model which now constitutes the vast majority of all stablecoins on the market. USD₮ is fully backed, transpar ent, and easy to use and many lenders and borrowers will pay a premium for USD₮ over other stablecoins.