The People Demand Yield
With new draft stablecoin legislation hot off the presses, we evaluate the implications and make the policy argument that stablecoins should pay interest.
I started Brogan Law to provide top quality legal services to individuals and entities with questions related to cryptocurrency. Cryptocurrency law is still new, and our clients recognize the value of a nimble and energetic law firm that shares their startup mentality. To help my clients maintain a strong strategic posture, this newsletter discusses topics in law that are relevant to the cryptocurrency industry. While this letter touches on legal issues, nothing here is legal advice. For any inquiries email aaron@broganlaw.xyz.
Quick question—how much would you pay for a dollar stablecoin? Easy answer: a dollar. This answer is (i) seemingly obvious (stop asking dumb questions Aaron!), (ii) theoretically justifiable, and (iii) empirically verifiable—the price of USDC on CoinMarketCap has been stable at within $0.0002 of a dollar since March of 2023.
Ok, but stay with me. If the Effective Federal Funds Rate (EFFR) was 100%, what would you pay for a dollar stablecoin? You might still want to say, “a dollar”, but if I was selling stablecoins for a dollar in this environment, nobody would buy them. That’s because in this environment, my dollar would be worth a lot less as a dollar stablecoin than it would be in some instrument that paid something close to the EFFR in interest, which would also cost just a dollar.
If you are an American, that might sound like an absurd hypothetical, but if you are Argentine it will make complete sense. There, when inflation approached 290% annually, citizens couldn’t get rid of their pesos fast enough. The problem became so debilitating that the old Peronist government literally made market rate exchanges of pesos illegal. And still, everyday in Buenos Aires people exchanged fresh pesos for dollars on the “blue market.” When the economic value of money is lower than the nominal value, people don’t want it.
Not to get too Austrian with you here, but value is an intangible representation of social capital, a dollar is just a unit of denomination. Money, as, collectively, a liquid agglomeration of this abstracted value, can take many different forms, and each of these forms have different properties. In the U.S. where trust-in-government is high and inflation is low, we’re happy to keep some money in a checking account and some money in cash. We lose money by doing so, but are generally comfortable with this because (i) these forms of money are convenient, (ii) it's not that much money, and (iii) we’re lazy.1
But only lunatics leave their life savings in checking accounts. In the U.S., just like in Argentina, when disposing money at meaningful scale, people respond to incentives and buy yield-earning assets like securities and high-yield savings account deposits, not cash or non-yielding cash-like assets like checking accounts.
Well, stablecoins are basically checking accounts.2
People struggle with this because the structure of checking accounts suggests that you put money into them, but there is no vault somewhere with all your paychecks in it. What you are actually doing is buying an instrument called a “deposit” from a bank.3 When that deposit is exchangeable at more or less any time for fiat currency, it is called a “demand deposit.”
In turn, the theoretical model of a stablecoin is this: you put one unit of currency in, and get back a token equal in value to the currency. Then you can go do whatever you want with it.4 The issuer holds some collateral, and you can freely swap back and forth between the token and the currency at more or less any time.
Much like you can send ACH, Wire or Zelle transactions between bank accounts— transferring your demand deposits—you can send stablecoins to other wallets, which then inherit the bundle of ownership rights that go with the token.
It’s the same thing.
This week, sponsors of House and Senate introduced bills for proposed stablecoin legislation, and all the rumblings suggest this a real chance of passing. There is a lot to like in these bills. If stablecoins are not already systemically important they will soon become so. And stablecoins have the same fatal weakness to bank runs as any other demand deposit. Bank runs are really bad! So you really do need pretty powerful oversight (and probably eventually deposit insurance, though that is not covered in this bill) to prevent that from happening.
So here is why I asked you at top what the value of a dollar stablecoin is. Both bills have (essentially) the same definition for a newly created regulatory category, the “payment stablecoin.” A payment stablecoin:
(A) means a digital asset— (i) that is or is designed to be used as a means of payment or settlement; and (ii) the issuer of which— (I) is obligated to convert, redeem, or repurchase for a fixed amount of monetary value; and (II) represents will maintain or creates the reasonable expectation that it will maintain a stable value relative to the value of a fixed amount of monetary value; and (B) that is not— (i) a national currency; or (ii) a security issued by an investment company registered under section(a) of the Investment Company Act of 1940 (15 8 U.S.C. 80a–8(a)).
By this definition, can stablecoins pay interest? You can pause here and put your answer in the comments before I continue.
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You might say, “absolutely not, if they paid yield they would be securities.” After all, this is the primary reason that stablecoins do not pay interest now. The major question of the last seven years of cryptocurrency regulation has been whether and under what conditions cryptocurrency tokens would fail the Howey test and thus be regulated as securities. One prong of Howey is “expectation of profit”, so, since stablecoins did not pay any interest and had a fixed value, it was generally assumed that they were regulatorily safe.
And, indeed, the “payment stablecoin” definition does exclude securities. But you’ll notice that the (B)(ii) carve out does not apply to securities writ large, it only applies to a subset of securities issued by “investment companies” under the Investment Company Act of 1940 (the “‘40 Act”).
Moveover, in what might be a drafting error, Section 13 of the House bill and 14 of the Senate bill specifically carve out stablecoins from U.S. securities laws, including the ‘40 Act. Paradoxically, this means, according to the language of the bills, that a ‘40 Act security “does not include a payment stablecoin issued by a permitted payment stablecoin issuer, as such terms are defined, respectively, in section 2 of the STABLE Act of 2025” while at the same time Section 2 of the bill defines “payment stablecoin” to exclude a security under the ‘40 Act.
I have no idea what to make of this! But it definitely means that stablecoins, if they are “payment stablecoins”, will not be prohibited from paying interest by U.S. securities law.
That leaves us to parse section (A) of the definition. In order to qualify as a “payment stablecoin” a digital asset must be “designed to be used as a means of payment or settlement”, be convertible into a fixed amount of monetary value, and “maintain or create a reasonable expectation that it will maintain a stable value relative to the value of a fixed amount of monetary value.”
As to the first part, there is no technological reason that something can’t be designed as a means of payment and also to pay interest. Modify USDC or USDT to pay interest, and do they cease being designed as a means of payment? I think not. The second part is a little trickier.
If a token pays interest, does it maintain a stable value relative to the value of a fixed amount of monetary value? Well this, as I’m sure you’ve been wondering, is why I asked the question about how much you would pay for a stablecoin at-top. Is a token’s value “stable relative to a fixed amount of monetary value” if it tracks the fed funds rate, or if it is always exchangeable for a single dollar bill? I suspect the drafters of this bill meant the latter, but the former is probably a truer representation of the actual value of the asset being exchanged for the token.
This is complicated, but it may be avoidable by simply making a token both interest bearing and convertible to a single USD. There may be some technological complexity, but it is achievable.
So I’ll ask again, now. Does this bill allow for stablecoins that pay interest?
It’s a trick question. They’ll decide in rulemaking.
The Normative Question
Since this draft language remains legally ambiguous to my eye5, and so there is still time to influence regulators and lawmakers, it is timely to ask the normative question—should stablecoins be allowed to pay interest or yield? Well, I think the affirmative case is apparent from the above.
Value is just a pile of abstracted social potential. Currency is an instantiation of value. Inflation is the typical property of currency that it becomes relatively less valuable over time. So, when you turn your abstract value into currency, by selling some other asset or performing some labor in exchange for it, you start becoming poorer immediately, and continue to do so until you convert it back into some non-currency asset.
Currency has lots of other good properties. It is handy to transact with, easy to understand, and, hey, maybe that inflationary property prods holders to spend it and that helps the economy. But it still kind-of sucks that it is always losing value.
The solution to this problem is for the currency to pay interest. In that case, the marginal increase in face-value from interest offsets the relative decrease of value-per-unit from inflation. You aren’t getting poorer any more!
There are many reasons this has not been the case in the past. Traditionally, fiat currency couldn’t pay interest because it was just pieces of paper in your wallet. Banks, on the other hand, have always paid interest, and will gladly sell you some high-interest deposits. But they don’t, generally, pay interest on checking accounts because (i) checking functions are modestly complicated and people want to get them for “free” and (ii) because people don’t demand it and are comfortable getting a tiny bit screwed on the margin.
Because of this history, we have an expectation that there is always a trade-off between liquidity and yield, but that expectation is just an artifact. There is no reason the market has to tolerate these properties going forward.
There will be some objections to this.
The canny among you might be saying, “if you give people more money to offset inflation, won’t that just increase inflation?” And in the limit, that may be true—you’d have to ask Larry Summers to know for sure. But in the case of existing stablecoins, it certainly is not. We know because this process is already happening, and the relevant question is who retains the returns on interest from stablecoin reserves, not whether they exist in the first place.
Stablecoins have been backed by yielding assets of one form or another since inception. Circle and Tether are not dumb enough to leave a giant pile of money sitting around as cash6, they buy yielding repurchase agreement (repos), money market funds (MMFs), and US Treasury Bills and make a ton of money for themselves by holding all of your money. Last year, Tether earned $13 billion through this process.
They have always had the cover from the aforementioned securities problem to argue that they could not pass this interest on to users, and so they have faced no real pressure to pay some of that money out. And because many non-US countries have highly inflationary or unstable currencies, these issuers may continue to see substantial demand abroad even without paying interest.
In the U.S., though, nobody wants to hold stablecoins. It’s just burning money. Or, if they do, it is only if they can put them into some sketchy “yield-earning protocol” that is really just lending and rehypothecating the tokens into who-knows-what. In my view, these will all collapse spectacularly on news of the next downturn, as they did in ‘22. That’s really not better.
So while regulators are sure to worry that interest-bearing stablecoins will be risky, this is the counterpoint. The substitute for interest bearing stablecoins is not cash, it is less-regulated risk-on assets. In a sense, this means that allowing stablecoins to pay interest might be less risky than not doing so. This is the same reason the Fed pays interest on bank deposits.
And, critically, if lawmakers and regulators use this juncture to make stablecoin-interest legal, it should not change the risk profile or back-end of stablecoin issuers at all. They’re already doing it! The real difference will be that instead of Tether getting unfathomably rich, token-holders will receive the fair rate for their capital contributions.
The change might not come right away—consumer rates will probably start low as issuers try to cling to their profit centers—but over time competition will drive them to within a few basis points of the EFFR. This in turn will be a virtuous cycle that helps bolster stablecoin adoption as a favorable alternative to cash.
Of course, regulators will also worry that if they do permit interest bearing stablecoins, the hype-market will push rates far higher than is sustainable, but this risk can be managed in exactly the same way it is for high-yield savings accounts. If that product can be safely managed, then so can interest bearing stablecoins. It will take regulation, but we can paint with a finer brush than prohibition here.
The truth is, it is an artifact of a strange coincidence of circumstance that gave us non-interest-bearing stablecoins in the first place. Stablecoins emerged during an extended period of near-zero interest rates. That meant that for much of their life, it made no difference whether they paid interest or not—there was none to be paid. At the same time, they were publicly analogized to currency, which is generally non-yielding, and the aforementioned securities problem made it very easy for everyone to sweep the question under the rug. But it doesn’t have to be that way.
From first principles, stablecoins should pay interest. They earn interest for someone, that someone should be the end user. It is all well and good to envision them as a payments instrument, but doing so at the exclusion of interest is pointlessly punitive to retail users. Just because fiat currency is always losing value doesn’t mean stablecoin holdings should as well.
I know it is very easy to anchor to the status quo, and that we are used to our stablecoins doing nothing, but this legislation is likely to be the only shot to create good policy for stablecoins. It’s worth it to get it right.
In Other News
Unfortunately, I’ve run out of time and space to cover everything else that happened this week. Even within this bill, there are other crucial issues. The current bill structure would appoint numerous different entities including the FDIC, the National Credit Union Administration, the Office of the Comptroller of the Currency (OCC), and individual state regulators to oversee administration. At the same time, it provides intensive federal oversight of state programs, which would effectively neuter the states’ ability to meaningfully differentiate them. I am all for the states serving as laboratories of democracy, but this bill should either give them a meaningful ability to do so or just regulate stablecoins itself. Paired with the numerous federal power centers, administration as written is sure to be, pardon my language here, a huge clusterfuck. Put it all in OCC and be done with it!
Hester Peirce also released her first statement as head of the newly announced SEC Crypto Task Force. The upside is that we may see legal cryptocurrency capital markets in the United States. If that is the case, this is literally the most important thing to happen in cryptocurrency since Trump’s inauguration. It pains me not to cover it here, so I may do a special mid-week newsletter supplement. Let me know if you would be offended by an extra email this week.
Otherwise, until next time.
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Another way to express this is that the transaction cost of switching money between yielding assets and units of exchange is higher than the return from doing so.
Yes, I know that checking accounts are highly regulated facets of a much broader fractional reserve system and so might have slightly different properties in some situations, but principally, they are the same.
I’ll admit that while this framework more accurately captures the true nature of retail banking transactions, there is some historical and legal complexity here. There were once, and indeed still are (in Switzerland, mostly), some vaults in banks where you could deposit things of value. In addition, bank deposits are not treated as “instruments” in certain situations, but rather “customer property.” This is particularly relevant when financial institutions go bankrupt, as customer property is typically returned before the “waterfall” that determines the disposition of the property of the estate.
In general, because, as we have covered before, the government sometimes thinks that stablecoin issuers should block you if you are holding units of their stablecoin and and you are sanctioned.
Elsewhere in the Senate Bill, but not the House Bill, there is a single reference to “appropriate liquidity and interest rate risk management standards applicable to permitted payment stablecoin issuers, which may not exceed what is sufficient to ensure the financial integrity of the permitted payment stablecoin issuer and the ability of the issuer to meet the financial obligations of the issuer, including redemptions…” This suggests that the bill contemplates stablecoins paying interest, but this is not made explicit anywhere. Given that, and given that this language is included in the Senate but not the House bill, my opinion remains that the language is “ambiguous.”