Stablecoins are a type of cryptocurrency that is designed to maintain a constant price over time. They are linked to an underlying asset such as the U.S. Dollar. Stablecoins provide all the benefits of DeFi and minimize volatility of cryptocurrency.
The market capitalization for crypto can fluctuate by billions per day. Even the top cryptocurrency––Bitcoin (BTC)––is subject to significant fluctuations in value. It’s not uncommon for Bitcoin, Ether, and other digital assets to fluctuate up to 10% in a given day.
This level of price volatility is not experienced by fiat currencies like the U.S. Dollar and the British Pound. Stablecoins can also be viewed as tokenized versions of fiat currencies. U.S. dollar based stablecoins are the most common form of stablecoin currently, including USDC and Dai.
How Do Crypto Exchanges Pay Stablecoin Interest?
Although crypto exchanges have been paying interest on users’ stablecoin holdings for some time, there is not much transparency about how they do it. Recent insolvencies have resulted from risky lending practices by some exchanges like BlockFi and Celsius. Voyager had to cease paying interest on its stablecoins due to failing to comply with regulatory requirements.
In the face of increased regulation and scrutiny, it is not clear if these exchanges will continue to pay interest. The interest generally comes from lending, but this has slowed during the bear market. Investors may move to decentralized lending models that are less subject to regulation, as DeFi is inherently transparent while crypto exchanges are not.
How Do DeFi Protocols Pay Stablecoin Interest?
Users can earn interest on their stablecoins using a variety of decentralized finance protocols. Curve, Compound, and Aave are top protocols used by investors to earn interest on their cryptocurrencies, and Curve specializes in stablecoin activities while the others are more generalized.
The protocols allow users to lock their stablecoins into smart contracts to earn interest. All of these options result in users receiving interest payments as a return for their investment. Plus, DeFi is transparent, so users can see exactly how their funds are being managed to earn this interest.
However, managing stablecoins between DeFi protocols is time consuming and can be confusing for newcomers. OUSD streamlines the process of earning interest through DeFi with its OUSD stablecoin. Users simply hold OUSD in their wallet and their token holdings will grow proportionally to the interest earned on the collateral backing OUSD.
Aave is a popular protocol for stablecoin strategies. Aave allows users to deposit their crypto assets into a “pool”, and then receive a loan back. The market demand for the particular pool determines the interest rate.
Generally, DeFi protocols pay interest through smart contracts that collect payments from users that take out loans via these protocols. Since there are no credit checks in crypto (yet), these protocols take collateral to ensure payments are made 100% of the time.
How Safe Is Earning Interest on Stablecoins?
Exchange insolvencies that offered stablecoin interest raise questions about the safety of earning interest on these assets. Exchanges are often opaque in their finances, and some have dealt in risky lending behaviors, leaving investors without their investment.
DeFi stablecoin lending, such as with OUSD, is fully transparent and regarded as a more safe alternative to CeFi lending. It’s also important to consider the stablecoin itself, as different stablecoins use different methods of collateralization.
Is It Worth Earning Yield on Stablecoins?
Stablecoins are a great way to generate yield while limiting your portfolio’s volatility. Stablecoins are less volatile than other cryptocurrency, which can be advantageous for investors looking to reduce risk.
However, stablecoins still have some risk. Investors should be aware of the possibility that interest rates could change and the possibility for liquidity problems. Stablecoins offer a great way to increase returns and not take on too much risk. This is especially true in the case of DeFi stablecoins like OUSD and Dai, as they are fully transparent and run by code, whereas exchanges may invest at their discretion.
Although stablecoins are relatively new in the cryptocurrency world, they are rapidly growing in popularity. Stablecoins, as their name implies, are more stable than other cryptocurrency. They can achieve stability by linking themselves to an asset like the US Dollar. How do stablecoins earn interest?
There are many ways to earn interest on your stablecoins. Understanding how these systems work will help you decide if it is worth your time. Do your own research before investing in any cryptocurrency-related product or service and understand the risks involved. Hopefully, this article helped you learn more about investing in stablecoins.