Understanding the First Principles of Stablecoin Yield: Behind the Clarity Act and the Davos Debate

Original Author | Aaron Zhang, Zoe Zhao

Recently, discussions around stablecoins have significantly intensified within global policy and financial circles. On one hand, the United States is advancing the structural crypto market bill, the Clarity Act, which aims to systematically define stablecoins, custody, yield attributes, and their regulatory boundaries. On the other hand, at the Davos World Economic Forum, Coinbase's CEO and the Governor of the Bank of France directly clashed over the question of whether stablecoins should generate interest. On the surface, this appears to be a debate about compliance and risk, but in essence, it points to a more fundamental issue: where does the interest generated by stablecoins actually come from? Does it constitute a new form of "money creation mechanism"? If this point is not clearly understood, all discussions about stablecoins are inevitably based on conceptual misunderstandings.

From the perspective of financial principles, the conclusion is actually not complicated. Earning interest on stablecoins is not equivalent to printing money. Its essence is highly consistent with the interest mechanism in the traditional financial system. Holders of stablecoins do not obtain returns out of thin air; rather, they temporarily transfer a "dollar-like asset" to the system or market for use. The system then participates in real financial activities with these funds and distributes the resulting returns to the capital providers according to established rules. This logic is fundamentally no different from bank deposits, money market funds, or short-term financing markets. What has always been worth discussing is not whether "stablecoins can earn interest," but rather the method of earning interest, the structure of risk assumption, and the actual destination of the funds.

1. On-chain Lending Model: Transparent Market Interest Rates and Contract Risks

From current market practices, earning interest on stablecoins has roughly formed several distinct approaches. The most representative is the on-chain lending model, exemplified by Aave and Compound. In this mechanism, users deposit stablecoins into a decentralized protocol, which then lends the funds to market participants with actual demand, including leveraged traders, market makers, and arbitrageurs. These borrowers pay interest for using the funds, and the interest is proportionally distributed to depositors through smart contracts. Since interest rates are entirely determined by the supply and demand of lending, this model is highly transparent. Its returns fluctuate with market conditions, and the main risks are concentrated in the security of the smart contracts and the liquidation mechanism itself.

2. RWA Model: "On-Chain Money Market Funds" and Custody Compliance Challenges

Another rapidly developing path in recent years is the interest-generating model of stablecoins backed by real-world assets (RWA), particularly U.S. Treasury securities. In this structure, stablecoin issuers or custodians allocate the corresponding funds into short-term Treasury bills or notes. The returns users receive are essentially equivalent to the U.S. Federal Reserve's benchmark interest rate minus operational and compliance costs. From a financial perspective, these stablecoins are more akin to "on-chain money market funds." Their popularity is not accidental but rather the result of a combination of high interest rate environments, institutional compliance demands, and the settlement efficiency of on-chain systems. This is also one of the key areas of focus for the Clarity Act. The primary risks associated with this model do not stem from on-chain mechanisms but are more concentrated in custody structures, jurisdictional issues, and regulatory coordination.

3. Centralized Wealth Management Model: Credit-Based Returns and Shadow Banking Risks

By contrast, stablecoin yield products offered by centralized platforms are closer to credit-based wealth management products in traditional finance. Users deposit their stablecoins into the platform, which then uses these funds through institutional lending, OTC trading, or quantitative strategies, and promises users a relatively stable annualized return. However, it is important to note that in this model, users do not receive market-based, on-chain verifiable interest, but rather credit-based interest paid by the platform according to its own balance sheet. Once the platform encounters liquidity or operational issues, users are legally regarded as general creditors, and this structure is essentially no different from the shadow banking system.

4. Algorithm/Subsidy Model: Water without a Source and Structural Fragility

The highest-risk and already repeatedly proven unsustainable model is the so-called algorithmic or subsidy-based interest-generating model. In this structure, returns do not come from genuine financial activities, but mainly rely on token subsidies, treasury discounts, or new capital covering old profits. The historical Terra/UST system has already fully demonstrated the fragility of this model. A simple yet extremely effective criterion for judgment is: if a stablecoin's returns are consistently significantly higher than the risk-free rate over the long term, and are almost independent of market conditions, then what users are likely receiving is not interest, but rather a return of their principal in advance.

No matter what form it takes, any sustainable yield-generating mechanism for stablecoins must clearly explain where the funds are actually going. A reasonable structure should be such that the funds first create value in real markets, for example, through interest from leveraged trading, market making, and arbitrage activities, or through returns from government bonds and corporate short-term financing, and then these returns are passed on to stablecoin holders via a protocol or platform. If one cannot clearly answer the questions of "who is paying for these returns," "why they are willing to pay," and "what would happen if they stop paying," then the returns themselves should be regarded with high caution.

From a broader perspective, the significance of earning interest on stablecoins goes far beyond merely offering individual investors an option for generating returns. It is gradually evolving into a crucial component of the next generation of financial infrastructure. For individuals, stablecoin yield provides a U.S. dollar-like cash flow tool with relatively controlled volatility and without the need to predict price direction. For institutions, it represents the ability to manage on-chain cash and serves as a substitute or supplement to certain traditional banking deposit functions. For the entire financial system, stablecoins are transitioning from mere mediums of exchange to financial assets that embody the value of time.

At the practical operational level, understanding that stablecoins can generate returns does not mean ignoring the associated risks. Any mechanism for earning returns from stablecoins should be evaluated within a clear risk-assessment framework. This includes examining the true source of the returns, who ultimately bears the risk, the extent to which returns are linked to market conditions, liquidity constraints, and the consequences in the worst-case scenario. Only when most of these questions have clear answers do the returns have real value for discussion.

Ultimately,Yielding stablecoins are not a radical financial innovation, but rather the oldest financial concept—interest—being systematically brought on-chain for the first time in a programmable, composable, and cross-border manner.The emergence of the Clarity Act, the central bank's cautious stance, and the open debate at Davos itself indicate that earning interest on stablecoins is no longer a marginal experiment, but rather a new form that is being taken seriously by the mainstream financial system.

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