Yield bearing stablecoins

Yield bearing stablecoins are tokens designed to hold a peg while earning interest for holders. Sounds good, right? However, where there’s yield, there’s also risk.

New narrative

The design varies, but the goal is quite clear – high yields with low price volatility plus asset mobility. Now it is not needed to interact directly with DApps, users can get yield bearing stablecoins, hold them within their private wallets ready to transfer, and still earn interest.

This creates new use cases and opportunities for users, which, as can be observed based on historical supply, they are happy to use.

What are yield bearing stablecoins?

A yield bearing stablecoin passes yield to holders via one of three mechanisms:

1. Rebasing balances (token count goes up at ~$1 price), e.g., rUSDY.
2. Increasing per-token redemption value (“accumulating” price-per-token rises), e.g., USDY.
   • The base token itself is the yield bearing instrument.
   • The same number of tokens; each one redeems for more dollars later.
   • Redemption path is typically with the issuer (often KYC/eligibility).
3. Yield accruing receipt/wrapper (non-rebasing share/receipt that’s redeemable for more underlying over time), e.g., sDAI (ERC-4626 over DSR) and sUSDe (staked USDe).
   • Receive a separate receipt/share token (the wrapper).
   • The exchange rate (price-per-share) of the wrapper vs the underlying increases; the underlying itself stays ~$1.
   • Usually redeemed on-chain for the underlying stable; no issuer off-ramp needed for the yield part.

One of the biggest advantages of such a token is that it does not require a separate action to earn yield. The user can just hold their tokens on a private wallet and not use it with other DeFi instruments and still earn with their assets.

However, it might create a false sense of security in some cases. Even though the token is in the wallet, the value of its collateral is still subject to risks related to the hack of the DeFi protocol from which the yield might be generated.

Yield bearing stablecoin risks

A yield bearing stablecoin’s security profile is determined by how its yield is generated.

• Off-chain yields (e.g., T-bills, bank deposits, money-market funds)
  Tokens that generate returns by holding traditional financial instruments such as Treasury bills or bank deposits rely on custodians and regulated intermediaries. While these assets are generally low-risk in absolute terms, they introduce new layers of exposure: custodial concentration risk if a single bank or broker is relied upon, legal risk tied to jurisdictional enforcement or claims on assets, and transparency risk since users must trust that reserves are managed as stated. In essence, the yield comes from access to the traditional financial system, but that same access embeds the stablecoin into regulatory and counterparty frameworks that can limit decentralization and resilience.
• On-chain yields (e.g., DeFi lending, AMMs, structured protocols)
  Tokens can also earn yield by engaging in decentralized finance directly – lending into protocols, providing liquidity in automated market makers, or participating in on-chain strategies. These mechanisms can be more transparent and composable than off-chain approaches, but they introduce smart contract risk, meaning that a code exploit could drain funds. They also rely heavily on third-party infrastructure like oracles for price feeds, keepers for automation, and DEX liquidity for exit. If any of these components fail, the yield stream can break down, creating systemic risk even when the core yield bearing stablecoin contract itself is secure. The yield here comes from users of DeFi paying to borrow tokens or trade against them, but the dependence on complex, interlinked protocols amplifies fragility.
• Incentive-driven yields (e.g., liquidity mining, token rewards)
  A third source of yield comes not from economic activity directly, but from incentive programs funded by token issuers or protocols. These schemes can offer high initial returns, but are ultimately subsidized rather than organically generated. As a result, they are reflexive: yields attract more capital, which inflates token prices, which temporarily sustains rewards – until the subsidies taper or sentiment reverses. When that happens, the exit can be sharp, leaving token holders exposed to sudden losses or illiquidity. While incentive-driven yields can bootstrap adoption and liquidity, they are inherently short-term and tied to the ongoing willingness (and ability) of sponsors to fund them.

Combining multiple yield sources in a single instrument to boost APY does not always diversify the risk. Sometimes it increases the risk alongside potential returns.

The risk that apply to yield bearing stablecoins include:

1. Off-chain reserve & custodian risk
   If any portion of backing sits with banks or custodians, operational failure, insolvency, freezes, or access delays can impair redemptions and cause a depeg. Exposure includes T-bill custody chains, money-market funds, repo counterparties, and cash deposit concentration at a small set of institutions.
2. Yield source risk
   Each instrument used to generate yield carries its own risk profile. Some yield sources can not only bring no revenue but also negatively impact the collateral (funding risk, liquidation risk, backing asset risks).
3. Smart contract risk
   Implementing best security practices and regular audits significantly improves the quality of the project and minimizes the risk of a hack. However, vulnerabilities happen, and in the worst case scenario, they can result in the complete loss of funds.
4. On-chain integrations risk
   Reliance on oracles, keepers, DEX liquidity, lending markets, and strategy vaults creates dependency risk. Oracle delays or manipulation, halted keepers, thin liquidity, or failures in integrated protocols can cascade into bad pricing, failed liquidations, or stuck redemptions – even if the core contract is solid. Consequently, evaluating their safety requires auditing the entire ecosystem of integrations, not just the core project in isolation.
5. Private key compromise / rug pull risk
   Active treasury management, rebalancing, and strategy deployment increase key-management exposure. Insecure multisigs, poor operational controls, or concentrated admin rights can enable theft or malicious upgrades. Robust key ceremonies, hardware isolation, threshold signatures, role separation, timelocks, and on-chain transparency are essential.
6. Legal risks
   Regulatory classification can trigger licensing, disclosures, or enforcement that halts issuance or redemptions. Weak segregation/custody, sanctions/KYC failures, or cross-border court orders can freeze reserves or addresses and impair redemption certainty.
7. Cascade effect risk
   The risks are often correlated; a failure in one area (custody, legal, yield source, smart contracts, integrations, or keys) can propagate to others, amplifying losses and increasing depeg and redemption risk.