Regulatory Push Raises New Questions for Yield-Generating Stablecoins

Since their emergence a decade ago, stablecoins have formed a bridge between the realm of crypto and traditional, real-world assets like the US dollar. Tied to flat currencies that are issued by central banks, stablecoins started life as electronic payment tokens, forming a new market that this month reached a record $300 billion in size. They can be used to make payments, settle deals and hold the returns from trading. As interest rates have risen, and the tokenization of assets has taken hold, stablecoins have taken on a new role as digital money offering a direct return on investment, making them ever more attractive to issuers and users alike.

However, growth has begun to falter. In the evolving landscape of digital assets, stablecoins have become central to a debate on innovation and regulation. Spurred by concerns about transparency, financial stability and old-fashioned competition, banks and regulators have pushed for curbs on stablecoin issuers offering a return on investment. 

In the EU, the Markets in Crypto-Assets (MiCA) regulation imposes strict licensing and reserve requirements on stablecoin issuers. Furthermore, they can't pass yields to holders as part of the regulated “e-money token” regime. In the US, the GENIUS Act passed in July created the first federal stablecoin framework, although individual states had already started to regulate the assets. Like MiCA, one of GENIUS's key provisions is an explicit prohibition on stablecoin issuers paying yields or interest. 

The appeal, and the downside

Before the new regulatory regime took hold, issuers could invest the reserves backing their stablecoins in a variety of assets, ranging from safe, short-term government securities to riskier instruments. The profits generated from these investments could then, in some cases, be passed on to holders as yield.

From a user’s perspective, yield transforms a passive instrument into an active financial tool. For retail holders, it offers a return on idle holdings. For institutions, it opens new efficiencies in treasury management and onchain liquidity, by allowing companies to keep their cash onchain, earning returns while remaining instantly accessible.

For issuers, offering yield can be a growth strategy. Circle, the company behind USDC, has experimented with passing on a portion of reserve income to users through a service offered by Coinbase. Other issuers have used yield-sharing to list on exchanges, allowing them to extend their reach within the crypto ecosystem. 

These same advantages have drawn the attention of regulators, raising questions about whether a stablecoin that pays interest may be both “stable” in regard to the fiat currency backing it as well as a risk to the stability of the wider financial system under existing law.

The moves to prohibit yield-bearing stablecoins also come after heavy lobbying from banking figures. European Central Bank advisor Jürgen Schaaf wrote in a blog post in July that more yield-bearing stablecoins “could divert deposits from traditional banks” and jeopardize financial stability in the region. 

“Bank-like stablecoins without full regulatory protections put the financial system at risk,” the Bank Policy Institute said in a statement on its website. “They are less regulated cousins of the money market mutual funds that required a bailout in 2008 and again in 2020.” 

The new rules – a blessing or a burden?

Reception of the regulatory regime has been mixed. On one hand it has been a welcome standardization, helping institutions build out their digital-asset capabilities. 

“It gives a broader set of stakeholders permission to act or to participate in the stablecoin ecosystem,” Matthew Homer, general partner at The Venture Dept and board member of Gemini and Ripple’s firm Standard Custody, said in an interview. However, the regulatory overhaul wasn’t strictly necessary, with legal issuance mechanisms already in place and “stablecoins would continue to evolve without it,” he said. Homer also voiced concerns about “an oligopoly” of stablecoin issuers comprising the larger financial institutions and first movers.

Some argue that the rules may even anchor stablecoin issuance within the banking sector, crimping opportunities for non-bank operators.

“If you look at the structure of MiCA, it makes it very much less attractive for a private issuer or a non-bank issuer to issue stablecoins. It makes it more likely for banks to issue stablecoins just in terms of regulation,” said Chuk Okpalugo, formerly product manager at issuer Paxos, who now opines and advocates through the newsletter Stablecoin Blueprint. “What they're doing is anti-competitive.” 

An evolving asset

Some yield-bearing stablecoins, such as Mountain Protocol’s USDM, have been wound down in the past months in response to new legislation. Yet despite the regulatory pushback, companies continue to launch new yield-bearing stablecoins, using new approaches to paying out returns while still respecting the law. 

Some have opted to remain onchain or operate outside of the US market. Others, like Solstice Finance’s USX and Ethena’s USDe, have focused on backing the assets with “synthetic dollar” models that combine real-world assets like US treasury bills with on-chain protocols. With “safe” yield becoming a defining factor for the competitiveness of digital assets, issuers’ success may lie in the ability to navigate this changing landscape.   

For fiat-backed stablecoins, this may be in the form of onchain lending and third-party protocols for generating yield. Stablecoin holdings can also be directed into yield-generating instruments such as tokenized US Treasuries or money market funds – products that already exist through institutional providers such as BlackRock and Ondo Finance. These funds hold traditional assets but issue digital tokens representing fractional ownership, creating a bridge between regulated yield and onchain liquidity.

Stablecoins or tokenized RWAs

The Venture Dept’s Homer sees a future where institutions hold much of their wealth in tokenized “low-risk” assets such as Treasury bills or money market instruments, generating yield continuously while maintaining instant convertibility. When payments are required, the tokenized real-world assets (RWAs) could be swapped into stablecoins to settle transactions.

“You can imagine a world where corporations actually hold zero dollars in stablecoins,” he said. “Instead, they hold all their money in tokenized treasuries and then convert to stablecoins only for a fraction of a second when moving the money.”

Meanwhile, retail users, less constrained by regulatory pressure, may migrate more onchain, using decentralized yield-bearing stablecoins not regulated by MiCA and the GENIUS Act. There could also be an influx of onchain protocols and decentralized apps allowing them to continue generating yield. 

For now, however, regulation continues to evolve. Banks are already lobbying for amendments to the GENIUS Act to tighten restrictions on yield, broadening its definition to cover lending, staking and even certain forms of tokenized real-world assets. Whether those efforts succeed will determine how much space remains for innovation and how much activity is pushed offshore and onchain.

For Okpalugo, it should mark the beginning of a new wave of innovation in traditional finance, although it’s unclear how competition will develop in this area of financial services and who will be eligible to take part and benefit.