Thursday, October 13, 2022

Stablecoins, meet 3% interest rates

The global rise in interest rates is finally beginning to percolate into the stablecoin sector. One of the effects of this rise is that centralized stablecoins like USD Coin and Gemini Dollar, which by default pay 0% to holders, are introducing backdoor routes for paying interest to large customers. (See my tweets here and here).

In the case of USD Coin, Coinbase refers to interest as a "reward." Gemini calls it a "marketing incentive." But less face it: they're really just interest payments.

The links I provide are the only public evidence of stablecoins doling out interest, but you can be sure that behind closed doors, large issuers like Circle/Coinbase, Gemini, and others are offering their largest customers -- in particular exchanges like Binance and Kraken -- the same deals.

Stablecoin issuers are offering interest to select customers because of the inexorable pressure of competition. After hovering near 0% for much of the last decade (see chart above), interest rates have ramped up to 3% in just a few months. Issuers hold assets to back the stablecoins that they've put into circulation, and now these previously barren assets are yielding 3%. That means a literal payday for these issuers. In the first quarter of 2022, for instance, Circle (the issuer of USD Coin) collected $19 million in interest income after making just $7 million the quarter before. In the second quarter of 2022, interest income jumped to $81 million. I suspect the third quarter tally will come in well above $150 million.

However, if they don't share at least some of this juicy reward, issuers risk having their customers flee to alternatives that do offer interest, like Treasury bills or corporate deposit accounts. And then the amount of stablecoins in circulation will shrink, eating into issuers' revenues.

And thus, we get to a world where Gemini is promising incentives and Coinbase rewards.

Alas, while large stablecoin holders may be benefiting from this trend, small holders of stablecoins are being ignored. They don't get to share in these sweet flows of interest income. Even folks with old-school U.S. savings accounts are being paid 0.17%!

Small stablecoin holders need to unite. By working together through a StablecoinDAO, their bargaining power vis-a-vis the big stablecoin issuers improves. They may be able to negotiate the same interest payments from Circle and other issuers that large stablecoin customers are getting.

For a good example of strength in numbers, take a look at the phenomenon of high-interest savings ETFs in Canada. Corporate customers of Canadian banks get far better interest rates on chequing deposits than retail customers do. A high-interest savings ETF manager bridges this divide. They collect money from retail customers, invest the proceeds in banks at the corporate rate, and then share the superior return with thousands of retail ETF unit holders.

A StablecoinDAO would work along the same lines as a high-interest savings ETF. People would deposit their stablecoins -- USD Coin, Gemini Dollar, Binance USD, USDP, Tether, Dai -- into a smart contract. In return they'd get a new stablecoin called, say, UniteUSD, which would be redeemable on demand into any of the DAO's underlying stablecoins. UniteUSD itself would be useful. It could be used for purchases, deposited into smart contracts, or traded on decentralized exchanges and whatnot.

StablecoinDAO would have the authority to swap one underlying stablecoin out with a new one. That potential threat would give the DAO the necessary leverage to negotiate interest payments. "Hey Circle, if you don't pay us 1% then we're going to shift the DAO's holdings over to Binance USD, your competitor." As a nuclear option, the DAO could threaten to buy short-term government debt.

The interest that the DAO receives would be funneled back to UniteUSD holders. 

In sum, that's how interest rates finally filter through to small stablecoin owners.

A few random afterthoughts about stablecoins and interest payments, in no particular order:

* A version of StablecoinDAO may already exist... in the form of MakerDAO, a decentralized-ish bank that issues Dai stablecoins. Think of MakerDAO as an organizing device for small stablecoin customers to extract interest from stablecoin issuers. These small holders deposit their stablecoins (USD Coin, USDP, etc) into MakerDAO smart contracts and receive Dai stablecoins in return, which are convertible to any of these underlying stablecoins on a 1:1 basis. MakerDAO negotiates with issuers for interest payments, sluicing this interest back to Dai owners.

* Some tricky regulatory issues arise when retail customers are promised a return. If StablecoinDAO were to pay interest on UniteUSD, then UniteUSD might be deemed to be a security, and thus StablecoinDAO would have to register with a securities agency. This could doom StablecoinDAO, or at least make things very difficult for it. (Remember, when PayPal used to pay interest to customers? It did through an SEC-registered money market mutual fund.)

* StablecoinDAO would become a stablecoin black hole: all other stablecoins would quickly get sucked up into it. Why? In a world where USD Coin and USDP can only pay 0% to small stablecoin holders, but depositing said coins into StablecoinDAO means earning 2%, then every small holder will deposit their funds into StablecoinDAO. The DAO would inhale the big stablecoins -- USD Coin, Binance USD, Tether, etc -- right out of circulation, leaving UniteUSD as the dominant stablecoin.

* As competition forces large issuers to share the interest they earn, this will have implications for the finances of those very issuers. Circle, the issuer of USD Coin, envisions being profitable in 2023, as the table below illustrates:

Source: Circle Q2 2022 financials [link]

A big part of Circle's estimates are based on higher flows of interest from the assets that it holds to back USD Coin. What this table isn't accounting for is the concurrent pressure to share interest income with USD Coin holders, both large and small ones, which threatens Circle's 2023 projections.


  1. Why can’t Circle or Gemini payout rewards on a tiered scale that’s based on amount of holdings?

    < 1000 receives .05%
    >1000 but < 5000 gets 1%

    1. Circle and Gemini could certainly come up with a good formula for paying interest. But then they might run into regulatory problems (which I get into in my second footnote). If stablecoins start offering a financial reward to holders, they may be classified as securities, and that could put their model at threat.

    2. Many thanks for sharing this post, very insightful and interesting. Question: why would being classified as securities put their model at threat? That is not entirely clear to me. Would that also be true in the European context?

    3. I think that a stablecoin being classified as a security would probably increase the regulatory costs to the issuer. And it might also limit the ability of users to transfer stablecoins on to someone else, by forcing extra paperwork onto them.

  2. already done by MakerDAO - look at the proposals from Coinbase and Gemini - it’s been underway for some months now.

  3. European regulations, including MiCA, forbid stablecoins (if structured as e-money tokens) from paying interest. This 0%-rule is fundamentally flawed. Here are links to short pieces that I wrote about this together with Willem Buiter and Anne Sibert in the Financial Times and CEPR:

    1. Interesting. Will give it a read.

    2. The EU rule (which will likely be adopted in the U.K. too) is explicitly designed to stop E-money tokens from replacing the national currency as the dominant form of savings.

      The primary rationale is that EMIs are not banks and therefore that diverting deposits away from banks reduces bank credit intermediation (which is a much bigger part of lending in Europe than the US).

      The EU rule (MiCA) also places caps on the daily volume that stablecoins can transact, above which they basically become subject to bank-like regulation.