How Do Stablecoins Make Money?

Looking to maximize your returns by investing in stablecoins? Learn the various ways stablecoins make money and how you can benefit from them.

Stablecoins have become increasingly popular in the world of cryptocurrencies due to their ability to maintain a stable value, unlike other volatile digital assets such as Bitcoin or Ethereum. Stablecoins offer a bridge between the stability of fiat currencies and the efficiency of blockchain technology. Their ability to maintain a constant value is underpinned by various strategies that enable them to generate income. But how exactly do stablecoins make money in this dynamic ecosystem? Read on to explore how these digital assets make money and ensure their stability in the volatile world of crypto.

Stablecoins Overview

Stablecoins are a type of cryptocurrency. They are designed to maintain a stable value compared to a reference asset. This reference asset is usually a fiat currency, like the US dollar, or a commodity, such as gold. By pegging their value to a stable asset, stablecoins reduce the volatility seen with other cryptocurrencies. This makes them more suitable for everyday transactions and as a store of value. There are different types of stablecoins. Fiat-collateralized stablecoins are backed by a physical reserve of fiat currency. Crypto-collateralized stablecoins use other cryptocurrencies to maintain their value. Algorithmic stablecoins rely on algorithms to control supply and demand for price stability. This stability is important for users seeking a reliable medium of exchange within the crypto ecosystem.

The rise of stablecoins is linked to their unique features. They offer the benefits of cryptocurrencies, like fast transactions and low fees, while maintaining the stability of traditional currencies. Stablecoins are commonly used in decentralized finance (DeFi) applications for activities like lending, borrowing, and yield farming. They help provide liquidity in various markets. Additionally, stablecoins enable smooth cross-border transactions. They reduce the conversion costs and time delays that are often associated with traditional banking systems. As digital currencies become more accepted, stablecoins may play a key role in connecting the crypto world with traditional finance. They are an important part of the changing financial landscape.

How Stablecoins Make Money

The business models and revenue streams of stablecoin companies vary depending on whether they are a centralized stablecoin or a decentralized one. 

Centralized Stablecoins

Centralized stablecoins are stablecoins that hold their reserve assets off-chain. These reserve assets are controlled by a central authority or financial institution. It is important to note that a stablecoin backed by a large amount of non-crypto assets is likely to be an off-chain centralized stablecoin. Examples of these stablecoins include Tether, USDC, Paxos Standard and the Gemini dollar.

Centralized stablecoins bring in revenue in a variety of ways.

• One of the most prominent ways stablecoin companies make money is through short-term lending and investing. These companies take a portion of the reserve assets and lend them out to others to earn interest, counting on the unlikelihood that a large number of stablecoin holders would redeem their collateral at once. This method mirrors how a bank operates by lending out the money customers place in savings accounts. An example would be when Tether loaned $1 billion to Celsius Network in October 2021. This deal would generate Tether between $50 to $60 million dollars per year. Another example would be when Circle, the company behind USDC, invests USDC reserves in various assets including cash equivalents, bonds and commercial paper.

• Centralized stablecoins also bring in revenue through charging issuance and redemption fees. You incur fees when you create stablecoins by handing over collateral or if you redeem your stablecoins for the original collateral. These fees tend to be relatively small, with Tether charging a 0.1% redemption fee. However, Tether does have a minimum withdrawal fee of $1,000 dollars to discourage low-volume redemptions.

Decentralized Stablecoins

Decentralized stablecoins are stablecoins that hold their reserve assets on-chain using other cryptocurrencies and smart contracts. This process helps solve the transparency issues that centralized stablecoin providers face. These stablecoins use smart contracts to eliminate the need for a third party.

• Decentralized stablecoins often issue an additional cryptocurrency along with the pegged stable cryptocurrency that serves different purposes such as governance and revenue sharing. For example, the MKR token of MakerDao is the more volatile governance token while the DAI token is the pegged stablecoin. 

• The MakerDao’s MKR token also provides rights to interest on collateral. The interest, which is known as the stability fee, is paid in MKR tokens, which are then subsequently burned. Burning decreases the supply of MKR and should lead to an increase in price. Many decentralized stablecoin projects issue cryptocurrencies as payment and incentives to the founding team. The decentralized autonomous organizations (DAOs) behind the decentralized stablecoins can then vote to issue more of these tokens to reward groups or individuals who perform vital roles for the project. 

Types of Stablecoins

Here are some common types of stablecoins:

Fiat-Backed Stablecoins

Stablecoins are linked to a fiat currency such as the US Dollar, Euro, or British Pound. Usually, for every stablecoin created, there is a matching amount of fiat currency held in reserve to support its value. Some examples are Tether and USD Coin.

Crypto-Backed Stablecoins

Stablecoins are supported by other cryptocurrencies instead of traditional fiat currencies. They utilize smart contracts to ensure they maintain their value, often needing to be over-collateralized to address the volatility of the underlying crypto assets. Examples of such stablecoins are DAI and sUSD.

Algorithmic Stablecoins

Algorithmic stablecoins use algorithms and smart contracts to manage the coin's supply, ensuring it stays aligned with a target price, typically a fiat currency. Unlike collateralized stablecoins, they do not depend on reserves, but instead, they operate based on supply and demand dynamics. Terra (LUNA) and Ampleforth (AMPL) are examples of this type.

Commodity-Backed Stablecoins

Stablecoins are supported by physical assets like gold, silver, or real estate, with their value tied to the worth of these underlying commodities. Paxos Gold (PAXG) and Tether Gold (XAUT) are examples of such stablecoins.

Hybrid Stablecoins

Hybrid stablecoins may utilize a mix of strategies, including fiat backing, crypto collateralization, and algorithmic methods, to achieve stability. This variety can improve their resilience to market fluctuations. An example of this is Reserve (RSV).

Are Stablecoins Worth Investing In?

Stablecoins can serve as an excellent investment and provide a wide array of investment opportunities. However, it is important to note that stablecoins have faced recent controversies regarding their collateral. It is important to do your due diligence for all investments, including stablecoins. 

How to Make Money On Stablecoins

There are several ways to make money on stablecoins. One common method is through yield farming, where you can earn interest on your stablecoin holdings by lending them out to others in decentralized finance (DeFi) protocols. Another way is through staking, where you can earn rewards by locking up your stablecoins in a smart contract to help secure the network. Additionally, you can take advantage of arbitrage opportunities by buying stablecoins at a lower price on one exchange and selling them at a higher price on another exchange. Lastly, investing in stablecoin-backed assets or using stablecoins for trading pairs on crypto exchanges can also be profitable. It's important to research and understand the risks involved before engaging in any of these methods.

Should You Use Stablecoins?

Stablecoins can be especially helpful if you are looking to borrow money on decentralized lending protocols such as Compound and Aave. They are a vital part of the DeFi ecosystem. On these protocols, users provide collateral to borrow funds. The users must over-collateralize or, in other words, provide more value in collateral than the asset that is borrowed. If the value of the collateral drops compared to the asset that is borrowed, the user is liquidated and loses the collateral. Stablecoins are useful when used as collateral on these borrowing and lending protocols because they carry less of a risk of liquidation. 

How Are Stablecoins Funded?

Stablecoins are funded in various ways, but the most common method is through the backing of a reserve of assets such as fiat currency, commodities, or even cryptocurrencies. These reserves provide stability to the stablecoin by ensuring that its value is pegged to the value of the underlying asset. Additionally, stablecoins can also be funded through the issuance of new coins through a process called minting, where new coins are created in exchange for a deposit of the reserve asset. Other stablecoins may generate funding through fees, interest on deposits or other revenue streams to maintain stability and liquidity.

Stablecoin Outlook for 2024 and Beyond

Stablecoins play a crucial role in the cryptocurrency ecosystem by providing stability and predictability for users. As the demand for digital currencies continues to grow, stablecoins are likely to become an essential tool for facilitating seamless and secure transactions in the digital economy. The vast majority of stablecoins should stay at the same value in 2024. However, stablecoins carry the risk of a bank run if the stablecoin lacks the proper backing. Some stablecoins have recently faced controversies regarding if they truly possess the amount of collateral that they claim. 

Frequently Asked Questions