Yield-bearing stablecoins are considered the next revolution in the continuously evolving stablecoin ecosystem. Over the past year, numerous projects have emerged, dedicated to developing yield-bearing stablecoin products.

In this article, I will offer a comprehensive overview of yield-bearing stablecoins, emphasizing the primary categories within this landscape: LSD-backed stablecoins, Treasury Bill-backed stablecoins, and yield-generating stablecoins. Following this, I will conduct a user analysis, with a focus on identifying the types of users who may or may not find yield-bearing stablecoins appealing.

I will present a SWOT analysis for yield-bearing stablecoins, shedding light on potential risk areas and opportunities for improvement within this space. Finally, I will share my thoughts regarding whether yield-bearing stablecoins are a product-market fit or not.

Overview of the Yield-Bearing Stablecoins Landscape

Yield-bearing stablecoins are a class of stablecoins that offer a return on investment to their holders simply by holding the asset.

The emergence of several stablecoins focused on delivering predictable and sustainable yields has generated significant optimism within the crypto ecosystem. Many view these yield-bearing stablecoins as nearly risk-free investments, poised to carve out a substantial niche in the stablecoin market. Notable figures such as Nic Carter are particularly bullish, projecting that within the next few years, yield-bearing stablecoins could capture 20-30% of the stablecoin market share.

However, there are also skeptics, myself included, who question the long-term viability and potential of these yield-bearing stablecoins.

I believe that this quote from iamnico.eth in his article called ‘’Yield-Bearing Stablecoins: Dope or Nope?’’ points out the inherent problems with yield-bearing stablecoin very clearly.

‘’Here’s the catch with APR-bearing stablecoins: Their inherent growth-focused monetary policy, while intriguing, risks creating a currency that’s de facto deflationary if money velocity diminishes. Economic slowdowns often follow such trends.

🤔 Simplified: If your money might be worth more tomorrow, why spend today? And if everyone thinks this way, is the economy truly thriving?’’

Let’s analyze these protocols individually so that we can have a better understanding of the yield-bearing stablecoin landscape. To do so, we will separately analyze LSD-backed, Treasury Bill-backed, and yield-generating stablecoins.

a) LSD-backed stablecoins

LSD-backed stablecoins are CDP model stablecoins that require over-collateralization by liquid staking tokens with liquidation risk. They allow holders to earn yields intrinsically while preserving the key attributes of crypto-backed stablecoins.

The main features of the treasury-bill backed stablecoins can be summarized as:

1. Utilizing LSD-Derivatives

2. Dependent on $ETH staking rewards

3. Requires over-collateralization and has liquidation risks

4. Unlocking the locked $ETH liquidity

LSD-backed stablecoins have been a popular category lately as investors saw potential in increasing their $ETH exposure with LSD-backed stablecoins. It is possible that with the increasing amount of $ETH being staked, LSD-backed stablecoins’ market share can also increase.

The first wave of LSD-backed stablecoins such as $GRAI, $R, and $eUSD proved that there is a demand to utilize LSD-Derivatives with stablecoins, however, the existing flaws of these stablecoins will be a hardship in the future. On the other hand, new LSD-backed stablecoins such as $mkUSD and $crvUSD made some improvements to the existing models which can be an exciting development. It should be noted that Ethena Labs’ $eUSD is completely a new model in the space that can inspire other builders to develop similar models.

I believe that LSD-backed stablecoins can be used as an effective leverage primitive for $ETH investors, however, due to a lack of capital efficiency caused by the over-collateralization requirement and liquidation risks, it can’t achieve stablecoin functionality. Moreover, LSD-backed stablecoins inherently do not work as money since their primary utility is to provide a yield to their holders, thus, they can’t serve as a medium of exchange.

b) Treasury Bill-backed stablecoins

Treasury Bill-backed stablecoins are the last innovation in the ecosystem. With the rise of interest rates in the US, some realized that this could be an excellent opportunity to provide risk-free interest for investors. Ondo Finance’s $USDY and Mountain Protocol’s $USDM are the two main examples in this space.

The main features of the treasury bill-backed stablecoins can be summarized as:

1. Permissioned/KYC requirement

2. The yield is dependent on US interest rates

3. The yield source is not volatile like in DeFi

While $USDM is a rebasable token, $USDY is a non-rebase token. As a result, the integration of $USDM into DeFi protocols will be challenging, and $USDY will surely face problems in terms of user experience.

I believe that when it comes to peg stability and the risk-free rate, stablecoins backed by treasury bills offer the best solution. However, their growth is dependent on U.S. interest rates, which are beyond their control. Therefore, external factors will play a key role in the future of this category.

Moreover, it should be noted that treasury bill-backed stablecoins do not offer a strong value proposition to the crypto community since these stablecoins are permissioned, meaning that not everyone can mint or use them and a 5% interest rate isn’t so competitive among the other protocols. It is possible that these protocols will target users from developing countries, however, lack of liquidity and in the case of lower yield in the future, they won’t be competitive against $USDC and $USDT. Furthermore, treasury bill-backed stablecoins inherently do not work as money since their primary utility is to provide a yield to their holders, thus, they can’t serve as a medium of exchange.

c) Yield-generating stablecoins

Yield-generating stablecoins provide their holders an automatic DeFi yield by utilizing the collateral in several protocols. To mint these stablecoins, users are required to put collateral in $USDC or other stablecoins. Sperax and Overnight can be given as examples in this category.

Many see yield-generating stablecoins as stablecoins, but I disagree with this take. These stablecoins do not function as stablecoins but as LP tokens. This means that yield-generating stablecoins do not act as money but act as an LP token which users earn yield by just holding. Even though this criticism can be directed at every yield-bearing stablecoin, it is clear that yield-generating stablecoins like $USDs and $USD+ do not even try to add another utility than being an LP token.

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

1. not a medium of exchange

2. counter-party risks

3. $USDC wrappers

4. DeFi yield

Many believe that yield-generating stablecoins can be an exciting initiative however, I don’t think they are stablecoins but $USDC staking providers. Thus, they don’t possess a unique value proposition in the ecosystem. As a result, I don’t see a bright future for this category as the product can easily copied or adopted by the existing projects with lower risks.

The Market of the Yield-Bearing Stablecoins: A User Analysis

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

For stablecoins, I believe that there are 3 main categories that we can analyze:

a) Institutions

Treasury bill-backed stablecoins can be a great way to have exposure to DeFi for the new institutions that are exploring the space. As these platforms require KYC/AML conditions and permissioned, institutions won’t have difficulty in terms of regulations and security while also utilizing the benefits of treasury bill-backed stablecoins.

These stablecoins can be very effective for institutions in developing countries whose access to the US dollar is limited.

Moreover, LSD-backed stablecoins can be a great tool for institutions that are familiar with the Ethereum and DeFi ecosystem as these stablecoins can help institutions increase their exposure to $ETH or in general to the Ethereum ecosystem.

b) Whales/LPs

I believe that Whales/LPs is the most exciting user category for yield-bearing stablecoins as these users have enough knowledge, experience, and capital to utilize yield-bearing stablecoins for high yield by developing leveraged trading strategies.

Most of the yield-bearing stablecoins can be utilized in several ways such as:

1. collateralized debt positions

2. yield-bearing

3. internet bond

4. leveraged yield-farming

Thanks to these utilities, whales/LPs can effectively develop trading/farming strategies and benefit from yield-bearing stablecoins.

LSD-backed stablecoins and yield-generating stablecoins can be great tools to utilize/diversify or increase exposure to certain assets for whales/LPs. I believe that even though the number of users may not be high, TVL can reach respectable levels for these stablecoins.

c) Retail users

Yield-bearing assets do not meet the requirements of stablecoin functionality. To explain briefly, with the concept of stablecoin functionality, I claim that a stablecoin must have specific features to be used as money in the digital space:

1. Medium of Exchange

2. Store of Value

3. Capital Efficiency

4. Fiat On-Ramp/Off-Ramp

5. Censorship Resistance

I believe that if a stablecoin can’t meet these requirements, it can’t scale, so it won’t be a bigger player in the stablecoin market.

In the case of yield-bearing stablecoins, I think that none of them achieves stablecoin functionality as they can’t be treated as a medium of exchange and are not capital efficient. These problems limit the ability of yield-bearing stablecoins to be used in transactions or buying/selling crypto assets. As retail traders use stablecoins mostly for these reasons, it is very hard for yield-bearing stablecoins to be adopted by this category of users. Also, the lack of liquidity and lack of use cases are the main obstacles that retail traders face while using yield-bearing stablecoins.

Moreover, considering that most retail users use stablecoins for transactions while the main utility of yield-bearing stablecoins is to hold the stablecoins to earn yield, there is a mismatch between the interest of the users and protocols. As a result, I believe any stablecoin that is not treated as a medium of exchange won’t be widely used by retail users.

SWOT Analysis of Yield-Bearing stablecoins

Strengths

• Dollarization: The U.S. dollar is a highly valued asset across the developing world, and yield-bearing stablecoins are expanding the reach of the U.S. dollar to these regions, where hyperinflation and devalution of national currency decreases purchasing power.

• Sharing the inherent yield: Circle and Tether do not share the inherent yield of USD that is deposited into their protocols. However, yield-bearing stablecoin protocols share this with the holders, thus, empowering the users.

• A new source of yield: While $ETH staking-based yield-bearing stablecoins introduce $ETH yield to institutions, treasury bill-backed stablecoins bring the U.S yields into DeFi, thus, both categories create new opportunities for investors.

• Store of value: Yield-bearing stablecoins can act as a store of value against inflation as they can provide a yield of around 5-8% in USD which is a great option for users.

Weaknesses

• Medium of exchange: Yield-bearing stablecoins are inherently limited to being used as a medium of exchange due to several reasons such as capital inefficiency, limited or permissioned use cases, and lack of liquidity. However, most importantly, since these stablecoins are generating yield by just holding no one wants to use them in transactions as they would lose the yield. As a result, there is limited reason to use yield-bearing stablecoins as money.

• Permissioned/Censorship: Treasury bill-backed stablecoins are permissioned and some people such as US citizens are not allowed to use them. As a result, there is a limitation on the adoption of these stablecoins. Moreover, there can be censorship risks since the protocols must follow the orders of regulatory agencies.

• Lack of use case/lack of liquidity: Due to several issues including scalability, liquidation risk, capital inefficiency, or permissioned use cases, there is a lack of liquidity and use cases for the yield-bearing stablecoins which limit the possibility of growth.

Opportunities

• Unique value proposition against fiat-backed stablecoins: As user empowerment increases across the ecosystem, there will be more criticism against fiat-backed stablecoins as they do not share the inherent yield of USD with the holders. This can be a good opportunity for yield-bearing stablecoins to differentiate themselves.

• Institutional adoption: Treasury bill-backed stablecoins can be a good starting point for institutions outside of the US, bringing new capital flow to DeFi.

Threats

• Competition: Most of the projects do not have a competitive advantage over others, so in a couple of years due to this competitive environment and lack of innovation/differentiation, some protocols may disappear.

• Profitability for protocol: The competitive nature of this space forces protocols to become more profitable for users, which in turn, decreases the profitability of these protocols. As a result, these projects may burn their capital and can’t live for a long period of time.

• Liquidity fragmentation: Due to the competitive environment, the ecosystem will possibly face a liquidity fragmentation problem which decreases the capital efficiency of these yield-bearing stablecoins.

• Yield sustainability: While some of the yield-bearing stablecoins depend on the treasury bill rate, others follow the $ETH staking rate. The problem with this method is that treasury bill rates will surely drop in the future and it is questionable the sustainability of the business as low rates may not be attractive for users. On the other hand, if the $ETH staking ratio increases, the yield rate will decrease accordingly, and this can be a future problem for these protocols as the lower yield may not be attractive.

Are Yield-Bearing Stablecoins PMF?

In the article, various types of yield-bearing stablecoins are discussed, each targeting a different market. Rather than analyzing them solely as a single category, it would be more beneficial to rank them based on their product-market fit and then evaluate the reasons behind this ranking.

Ranking the yield-bearing stablecoins based on PMF:

1. Treasury bill-backed stablecoins: With the rise of interest rates in the US coinciding with the rise of stablecoins builders realized that treasury bill-backed stablecoins can be a great tool for users. While it is clear that the average DeFi user won’t use treasury bill-backed stablecoin due to privacy, censorship, lack of use cases, and liquidity reasons, it is possible that institutional investors outside of the USD can be excited to use treasury bill-backed stablecoins. However, I should note that when the yield drops, there won’t be further utility for these stablecoins against the fiat-backed stablecoins. Thus, I believe that treasury bill-backed stablecoins can be great tools to access the US dollar across the world for institutions or accredited investors, the market may not be as big as many believe.

2. LSD-backed stablecoins: I am skeptical about the future prospects of LSD-backed stablecoins in reaching the potential many envision as the design of these protocols includes many flaws such as capital inefficiency, liquidation risk, easy to be copied, no real innovation that limits the ability of these stablecoins to grow/scale and to be treated as a medium of exchange. However, it is also clear that they are good financial primitives for leveraging $ETH, so even though there will be a place in the market for LSD-backed stablecoins, it won’t be as big as many envisioned. On the other hand, new protocols such as Ethena, a delta-neutral stablecoin that utilizes LSTs, can create a new model that eliminates these problems.

3. Yield-generating stablecoins: I don’t believe that yield-generating stablecoins offer a competitive value proposition that differentiates in the stablecoin market. I think that these products are only wrapped $USDC or LP tokens that let users earn interest on their stablecoins with several counter-party risks. Also, it is very easy for other stablecoins to copy the business model by just creating a liquid staking version of their stablecoins to challenge yield-generating stablecoins. As a result, I believe that yield-generating stablecoins are not a product-market fit.

The stablecoin market is still in its infancy and there are several upcoming projects that aim to challenge the current models. We’ll see together how the yield-bearing stablecoin landscape evolves in the near future. However, it should be noted that there is still time for us to find a product-market fit in this niche.