Written by: Caesar

Compiled by: Xiaobai Navigation Coderworld

Stablecoins with yields are considered the next revolution in the evolving stablecoin ecosystem. Over the past year, many projects have emerged to develop stablecoin products with yields.

In this article, I will provide a comprehensive overview of the interest-bearing stablecoin landscape, highlighting the main categories in this space: LSD-backed stablecoins, Treasury-backed stablecoins, and other stablecoins that generate yields. Following this, I will conduct a user analysis focused on identifying which types of users may or may not find interest-bearing stablecoins attractive.

I will conduct a SWOT analysis of interest-bearing stablecoins, shed light on potential risk areas and opportunities for improvement in this space. Finally, I will share my thoughts on whether interest-bearing stablecoins have market fit.

Overview of interest-bearing stablecoins

Interest-bearing stablecoins are a type of stablecoin that provides holders with a return on investment by simply holding the asset.

The emergence of several stablecoins focused on providing predictable and sustainable returns has generated tremendous optimism in the crypto ecosystem. Many view these interest-bearing stablecoins as virtually risk-free investments that are expected to carve out a sizable niche in the stablecoin market. Notable figures such as Nic Carter are particularly optimistic, predicting that interest-bearing stablecoins could capture 20-30% of the stablecoin market share in the next few years.

However, skeptics, myself included, have questioned the long-term viability and potential of these interest-bearing stablecoins.

“The key to APR stablecoins is this: while interesting, their inherent growth-oriented monetary policy runs the risk of slowing the velocity of money, which, if it happens, tends to lead to a slower economy. In short: if your money could be worth more tomorrow, why spend it today? If everyone thought that, would the economy really thrive?”

Let’s analyze each of these protocols one by one to better understand the interest-bearing stablecoin landscape. To do this, we will analyze LSD-backed, Treasury-backed, and yield-generating stablecoins separately.

a) LSD-backed stablecoins

Stablecoins supported by LSD require liquidity pledgeTokenOvercollateralized CDP model stablecoins are subject to liquidation risk. They allow holders to earn yield while retaining the key properties of crypto-backed stablecoins.

The main features of LSD-backed stablecoins can be summarized as follows:

• using LSD derivatives;

• Reliance on Ethereum staking rewards;

• Requires overcollateralization and carries liquidation risk;

• Unlock locked Ethereum liquidity.

LSD-backed stablecoins have become a hot category recently as investors see the potential of LSD-backed stablecoins as the amount of staked Ethereum increases. As the amount of staked Ethereum increases, the market share of LSD-backed stablecoins may also increase.

The first wave of LSD-supported stablecoins, such as $GRAI, $R, and $eUSD demonstrate that there is a demand for stablecoins that utilize LSD derivatives, however, the existing flaws of these stablecoins will cause difficulties in the future. On the other hand, new LSD-backed stablecoins such as $mkUSD and $crvUSD make some improvements to the existing model, which may be an exciting development. It should be noted that Ethena Labs' $eUSD is a completely new model that can inspire other developers to develop similar models.

I believe that LSD-backed stablecoins can serve as an effective leverage primitive for Ethereum investors, but they cannot achieve stablecoin functionality due to capital inefficiencies caused by excess collateral requirements and liquidation risk. In addition, LSD-backed stablecoins do not inherently have monetary functions because their main purpose is to provide holders with returns and therefore cannot serve as a medium of exchange.

b) Treasury-backed stablecoins

Treasury-backed stablecoins are the latest innovation in the ecosystem. As interest rates in the United States rise, some have realized that this could be a great opportunity to provide investors with risk-free interest. Ondo Finance’s $USDY and Mountain Protocol’s $USDM are two prime examples in this space.

The main features of a Treasury-backed stablecoin can be summarized as follows:

• Requires licensing/KYC;

• The yield depends on U.S. interest rates;

• The income stream is not as volatile as DeFi.

Although $USDM is a rebaseToken，但$USDY 是不可变基Token。因此，$USDM 集成到 DeFi 协议中将具有挑战性，而$USDY 在用户体验方面肯定会遇到问题。

I believe that Treasury-backed stablecoins offer the best solution in terms of exchange rate stability and risk-free interest rates. However, their growth depends on US interest rates, which is beyond their control. Therefore, external factors will play a key role in the future development of this category.

Additionally, it should be noted that Treasury-backed stablecoins do not provide aCommunityProvides a strong value proposition, as these stablecoins require permission, which means not everyone can mint or use them, and 5%'s interest rate is not competitive with other protocols. These protocols may target users in developing countries, but the lack of liquidity and the prospect of declining future returns puts them at a disadvantage in competing with USDC and USDT. In addition, Treasury-backed stablecoins do not act as currencies in nature, as their main purpose is to provide yield to holders, and therefore cannot be used as a medium of exchange.

c) Yield-generating stablecoins

Yield-generating stablecoins provide holders with automated DeFi yields by using collateral in several protocols. To mint these stablecoins, users need to collateralize them with USDC or other stablecoins. Sperax and Overnight can be examples of this category.

Many people consider yield-generating stablecoins to be stablecoins, but I disagree. These stablecoins do not function as stablecoins, but rather as LP tokens. This means that yield-generating stablecoins do not function as currencies, but rather as LP tokens that users can earn yield on just by holding them. While this criticism can be leveled at every yield-generating stablecoin, it is clear that yield-generating stablecoins like $USDs and $USD+ do not even attempt to add other uses besides being LP tokens.

The main features of yield-generating stablecoins can be summarized as follows:

• It is not a medium of exchange;

• There is counterparty risk;

• USDC packaging;

• DeFi income.

Many people think that yield-generating stablecoins could be an exciting move, however I do not consider them to be stablecoins, but rather USDC collateral providers. Therefore, they do not have a unique value proposition in the ecosystem. Therefore, I am not bullish on the future of this category as the products can be easily copied or adopted by existing projects with less risk.

The Market for Interest-Bearing Stablecoins: User Analysis

To determine if a protocol has product-market fit, we need to look at potential customers/users and how they would view/use the protocol.

For stablecoins, I think we can analyze 3 main categories:

a) Institutions

Treasury-backed stablecoins can be an excellent way for new institutions that are exploring the space to enter DeFi. Since these platforms require KYC/AML conditions and licenses, institutions have a difficult time navigating regulations andSafetyThere will be no difficulties in this regard, and at the same time, the benefits of stablecoins backed by government bonds can be utilized.

These stablecoins can be very effective for institutions in developing countries where access to the U.S. dollar is limited.

Additionally, LSD-backed stablecoins can be an excellent tool for institutions familiar with the Ethereum and DeFi ecosystem to increase their exposure to Ethereum or the entire Ethereum ecosystem.

b) Whales/LPs

I believe that whales/LPs are the most exciting user category for interest-bearing stablecoins because these users have enough knowledge, experience, and capital to leverage interest-bearing stablecoins at high yields by developing leveraged trading strategies.

Most interest-bearing stablecoins can be used in several ways:

1. collateralized debt positions;

2. income;

3. Internet bonds;

4. Leveraged liquidity mining.

Due to these use cases, whales/LPs can effectively develop trading/mining strategies and benefit from interest-bearing stablecoins.

LSD backed stablecoins and yield generating stablecoins can be a great tool for whales/LPs to leverage/diversify or increase exposure to certain assets. I think the TVL of these stablecoins can reach a respectable level even though the number of users may not be high.

c) Retail users

Yield-bearing assets do not meet the requirements of stablecoin functionality. In short, according to the concept of stablecoin functionality, stablecoins must have specific functions to be used as currency in the digital space, such as:

• Medium of exchange;

• Store of value;

• Capital efficiency;

• Fiat currency entry/exit;

• Anti-censorship.

I think if a stablecoin doesn’t meet these requirements, it won’t be able to scale, so it won’t become a bigger player in the stablecoin market.

Regarding interest-bearing stablecoins, I believe that none of them have achieved stablecoin functionality as they cannot be considered a medium of exchange and are not capital efficient. These issues limit the ability of interest-bearing stablecoins to be used in trading or buying and selling crypto assets. Since retail traders mainly use stablecoins for these reasons, interest-bearing stablecoins are difficult to be adopted by such users. In addition, lack of liquidity and lack of use cases are also major barriers faced by retail traders in using interest-bearing stablecoins.

Furthermore, given that most retail users use stablecoins for transactions, and the main use of interest-bearing stablecoins is to hold stablecoins to earn yield, there is a mismatch between user interests and protocols. Therefore, I believe that any stablecoin that is not considered a medium of exchange will not be widely used by retail users.

SWOT Analysis of Interest-Bearing Stablecoins

Advantages

• Dollarization: The U.S. dollar is a highly recognized asset in the developing world, and interest-bearing stablecoins are extending the dollar’s influence to these regions where hyperinflation and devaluation of national currencies have reduced purchasing power.

• Sharing Intrinsic Gains: Circle and TethBitcoin does not share the inherent returns on the dollars deposited into its protocol with users. However, interest-bearing stablecoin protocols share these returns with holders, thereby empowering users.

• New sources of yield: While interest-bearing stablecoins based on Ethereum collateral introduced Ethereum yield for institutions, Treasury-backed stablecoins brought US yield to DeFi, so both categories created new opportunities for investors.

• Store of Value: Interest-bearing stablecoins can protect against inflation as they can provide users with a yield of approximately 5-8% in USD, which is a good choice for users.

Disadvantages

• Medium of Exchange: Interest-bearing stablecoins are inherently limited in their use as a medium of exchange for several reasons, including capital inefficiency, limited or permissioned use cases, and illiquidity. Most importantly, however, since these stablecoins generate yield simply by holding them, no one wants to use them in transactions because they would lose the yield. Therefore, there are limited reasons to use interest-bearing stablecoins as money.

• Licensing/Censorship: Treasury-backed stablecoins require licensing, and some people (like US citizens) are not allowed to use them. Therefore, there are limitations to the adoption of these stablecoins. Additionally, there may be censorship risks as the protocol must comply with the orders of regulators.

• Lack of use cases/lack of liquidity: Due to several issues including scalability, liquidation risk, capital inefficiency, or permissioned use cases, interest-bearing stablecoins suffer from liquidity and lack of use cases, which limits the potential for growth.

Chance

• Unique value proposition vs. fiat stablecoins: As user power grows in the ecosystem, there will be more criticism that fiat stablecoins do not share the inherent benefits of the dollar with holders. This could be a good opportunity for an interest-bearing stablecoin to differentiate itself from other stablecoins.

• Institutional adoption: Treasury-backed stablecoins can be a good starting point for institutions outside the United States, bringing new capital inflows to DeFi.

WeiThreat

• Competition: Most projects have no competitive advantage over other projects, so in a few years some protocols may disappear due to this competitive environment and lack of innovation/differentiation.

• Profitability of the protocol: The competitive nature of this space forces protocols to be more profitable for users, which in turn reduces the profitability of these protocols. As a result, these projects may burn their capital and fail to survive for long.

• Liquidity Fragmentation: Due to the competitive environment, the ecosystem may face liquidity fragmentation, which reduces the capital efficiency of these interest-bearing stablecoins.

• Sustainability of earnings: While some interest-bearing stablecoins rely on Treasury bond rates, others follow Ethereum collateral rates. The problem with this approach is that Treasury bond rates will surely fall in the future, and the sustainability of the business is questionable, as low interest rates may not be attractive to users. On the other hand, if the Ethereum collateral ratio increasesXiaobai Navigation, yields will fall accordingly, which could be a problem for these protocols in the future as lower yields may not be attractive.

Do these yield-yielding stablecoins meet market demand?

The various types of interest-bearing stablecoins discussed in the article each target different markets. Rather than analyzing them as just a single category, it would be more beneficial to rank them based on their product-market fit and then evaluate the reasons behind the ranking.

Ranking interest-bearing stablecoins based on product-market fit:

1. Treasury-backed stablecoins: As US interest rates rise this has coincided with the rise of stablecoin builders who are realizing that Treasury-backed stablecoins can be a great tool for users. While it is clear that the average DeFi user will not use Treasury-backed stablecoins due to privacy, censorship, lack of use cases, and liquidity reasons, institutional investors outside of the USD may be excited to use Treasury-backed stablecoins. However, I should point out that when yields decline, these stablecoins will no longer have further utility relative to fiat-backed stablecoins. Therefore, I believe that Treasury-backed stablecoins can be a great tool for institutional or accredited investors to access USD across the globe, but the market may not be as large as many believe.

2. LSD-backed stablecoins: I am skeptical that LSD-backed stablecoins will achieve the potential that many envision, as the design of these protocols contains many flaws such as capital inefficiency, liquidation risk, easy copying, no real innovation, etc., which limit the ability of these stablecoins to grow/scale and be seen as a medium of exchange. However, it is clear that they are good financial primitives for Ethereum to leverage, so while LSD-backed stablecoins will have a place in the market, it will not be as large as many envision. On the other hand, new protocols such as Ethena use LST to create a new model that eliminates these problems.

3. Yield-generating stablecoins: I do not believe that yield-generating stablecoins offer a distinct competitive value proposition in the stablecoin market. I believe these products simply wrap USDC or LP tokens that allow users to earn interest on stablecoins while taking on some counterparty risk. Moreover, other stablecoins could very easily replicate this business model by simply creating a liquid collateralized version of the stablecoin to challenge yield-generating stablecoins. Therefore, I believe that yield-generating stablecoins have the lowest product-market fit.

The stablecoin market is still in its infancy, with several upcoming projects aiming to challenge the current model. Let’s take a look at how the interest-bearing stablecoin landscape will develop in the near future. However, it should be noted that we still have time to find product-market fit in this niche.

The article comes from the Internet:Interest-bearing stablecoins: current market landscape and potential research

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