Stablecoin yields on exchanges: Two models, distinct risks

Centralised exchanges offer stablecoin remuneration via two primary models: activity-based and reserve-based.

Activity-based remuneration, exemplified by Binance, derives yields from the exchange's market activities such as lending, trading, and market-making.

These yields are highly volatile, strongly co-moving with stablecoin borrowing rates, which can reach over 20 percent during crypto rallies.

In contrast, reserve-based remuneration, implemented by Coinbase and Circle for USDC, transmits returns from the stablecoin issuer's reserve assets.

These yields are much more stable and closely track monetary policy rates, akin to traditional cash-management instruments.

This model aims to support broad stablecoin adoption by offering a reliable savings vehicle.

The two remuneration models imply distinct yield dynamics following changes in monetary policy.

Under the reserve-based model, a direct link exists: policy rate shifts directly alter the return on reserve assets, thus impacting the yield paid to holders.

Coinbase's USDC yields consistently move with the policy rate, albeit with some delay after cuts.

For the activity-based model, yields reflect both benchmark yields and the scale of stablecoin-related activities.

A policy rate hike may increase benchmark yields but reduce crypto market activity, potentially offsetting effects.

Binance's USDT yields tend to remain flat after rate hikes, suggesting the activity channel dominates after monetary loosening.