The Hidden Risks in Stablecoin Yield

Stablecoin yield can be confusing due to varying sources of revenue. The same '8% APY' on a dashboard can come from short-term US Treasury bills, a lending spread, or token subsidies that may run out.

The Terra Anchor Protocol promised 19.5% returns in 2021 and 2022 but lost tens of billions of dollars when its peg broke in May 2022. This highlights the importance of understanding where stablecoin yield comes from.

There are three primary sources: T-bill backing, lending spreads, and protocol incentives. T-bill-backed products like Ondo's OUSG tokenize exposure to short-term Treasuries, offering yields similar to those earned by the US government.

Lending-market yields on platforms like Aave and Compound can be higher but come with real, variable credit exposure. On the other hand, protocol incentives, new tokens minted to attract deposits, are not yield in any real sense, but rather a marketing budget disguised as an interest rate funded by token inflation.

To determine which bucket you're in, ask who's actually paying you and from what revenue. If it's 'the US Treasury, indirectly,' you're in the first bucket; if it's a borrower on the other side of a loan, you're in the second. If nobody can give you a straight answer, you should treat the APY as temporary by design.

Safety in stablecoin yield isn't one variable but at least four separate risks stacked on top of each other: peg risk, counterparty risk, smart contract risk, and yield source risk.