The Great Yield Compression: Deconstructing the Decline of CeFi Stablecoin Returns

Report Date: 2026-02-25 10:14 UTC

Analyst Perspective: Web3 Macro & Cross-Market Capital Flows

Executive Summary

The observable, multi-quarter decline in USDT/USDC yield rates on top-tier centralized exchanges (CEXs)—from promotional highs of 10–22% in late 2024 to a current range of 1–6%—is not an isolated pricing anomaly. It is the synthesized outcome of four convergent forces:

1. the normalization of Traditional Finance (TradFi) risk-free rates post-Fed hiking cycle, which narrowed the arbitrage window for exchange-subsidized yields;

2. a structural downturn in crypto leverage demand during a market consolidation phase, drying up the organic source of lending yield;

3. a post-regulatory pivot by CEXs away from aggressive user acquisition via yield subsidies toward compliance-first capital preservation; and

4. a decisive capital migration toward higher-yielding, transparent on-chain alternatives in DeFi and Real-World Assets (RWA).

The compression signals a maturation of crypto capital markets, where yield is increasingly priced by transparent, on-chain supply-demand mechanics rather than centralized platform subsidies. The forward path points not to a reversion to past highs, but to the emergence of bifurcated yield markets: low-liquidity, utility-driven returns on CEXs versus competitive, risk-adjusted yields in permissionless protocols.

1. Macroeconomics & TradFi Interest Rate Transmission

The primary, often overlooked anchor for all USD-pegged stablecoin yields is the risk-free rate set by U.S. monetary policy. Stablecoins like USDC (and to a managed degree, USDT) are backed by short-duration U.S. Treasury bills and cash equivalents. The revenue generated from these reserves forms the theoretical ceiling for sustainable, non-subsidized yield that can be passed to holders.

Transmission Mechanism Analysis: Historically, during the near-zero interest rate policy (ZIRP) era of 2020-2021, the yield on stablecoin reserves was negligible. CEXs could offer double-digit promotional APYs (e.g., 10-22%) as a loss-leading user acquisition strategy, because the opportunity cost of capital was low and the marketing ROI from user growth was high. CoinMarketCap

The Fed's hiking cycle, which brought the risk-free rate to ~3.75%, fundamentally altered this calculus. It established a hard, investable benchmark. Institutional capital could now earn ~4% in Treasuries with minimal counterparty risk, making subsidized 15% CEX yields economically unsustainable at scale. The "yield subsidy" became a direct and costly expense against rising risk-free returns.

The critical nuance: The transmission is not direct. CEXs do not simply pass through T-bill yields. Their Earn products are primarily funded by internal demand for liquidity—namely, from margin traders and quantitative firms paying funding fees. The TradFi rate acts as a gravitational floor and a capital allocation signal. When the risk-free rate rises, the "subsidy gap" that CEXs must fund to offer above-market yields widens, increasing the economic pressure to rationalize those programs.

2. CeFi Internal Supply/Demand Fundamentals & Leverage Cycles

The organic engine for CeFi stablecoin yield is internal platform demand for leverage, not reserve income. The dominant yield-generating mechanisms are:

1. C2C (Customer-to-Customer) Lending: User deposits fund margin loans for other users.
2. Funding Rate Arbitrage: Market makers borrow stablecoins to fund perpetual swap positions, paying the funding rate.
3. Exchange Quantitative Operations: Capital provision for internal market-making and liquidity.

The health of this engine is dictated by the crypto market's leverage cycle.

Current Leverage Cycle Diagnostics:

Analysis: The data paints a clear picture of leverage consolidation, not expansion. Total Open Interest (OI), while substantial in absolute terms, has shown stability rather than growth. More tellingly, funding rates across major tokens are neutral to negative. A negative funding rate indicates that perpetual swap prices are trading below spot, and short positions are paying longs to maintain their positions. This reflects:

• Cautious sentiment and a lack of aggressive long-side leverage demand.
• Potential dominance of hedging or basis-trade activity over directional speculation.

Direct Correlation to Yield Decline: The demand for borrowing stablecoins to fund long leveraged positions is weak. Simultaneously, with shorts paying funding, there is less revenue generated from the funding rate market for liquidity providers. This creates a fundamental supply-demand imbalance: stablecoin deposits (supply) are abundant in a risk-off environment, while borrowing demand (for leverage) is subdued. In a market-driven system, this imbalance forces yields down.

Historical Context: Compare this to Q4 2024 or Q1 2025, during promotional periods where APYs reached 10-22%. CoinMarketCap Those periods likely coincided with higher volatility, bullish sentiment, and positive funding rates—conditions that create intense demand for borrowing stablecoins to enter leveraged longs. The current market phase is characterized by consolidation and deleveraging, directly starving the CeFi yield engine.

3. Regulatory Environment & Compliance Pressures

The regulatory landscape has shifted from ambiguous hostility to structured compliance, forcing a strategic overhaul of CEX yield products. The previous era of aggressive yield subsidies carried existential legal risks, as evidenced by high-profile enforcement actions.

Key Regulatory Catalysts for Yield Rationalization:

Analysis of the Pivot:

1. From "Growth-at-all-Costs" to "Compliance-First": The SEC's 2023 lawsuit against Gemini Earn cast a long shadow, categorizing yield-bearing accounts as securities. This forced all major CEXs to scrutinize their Earn programs, likely leading to behind-the-scenes restructuring, clearer (and more limited) terms, and the removal of the most aggressive, unsustainable promotional rates that could be deemed speculative investment contracts.
2. The Dismissal as a New Paradigm, Not a Return: The SEC's dismissal of the Gemini case in early 2026—following the 100% return of user assets through bankruptcy proceedings—signals a more pragmatic regulatory approach under the current administration. DL News However, this did not greenlight a return to the old model. Instead, it validated the path of compliance and asset safeguarding. Exchanges now understand that yield products must be structured within clear regulatory guardrails, inherently limiting their risk profile and potential returns.
3. Systemic Risk Mitigation: The "clawback" clauses now embedded in terms of service (e.g., OKX's agreement allowing it to use Savings interest to cover margin call losses) exemplify the shift. OKX Yield is no longer a pure marketing giveaway; it is a risk-managed component of the exchange's capital ecosystem, designed to buffer platform risk. This structurally caps yields.

4. Capital Diversion: The Rise of DeFi, RWA & Native On-Chain Yields

Sophisticated capital is voting with its wallet, migrating to on-chain venues that offer superior risk-adjusted returns and transparency. This capital flight undermines the pricing power of CEXs and fragments the yield market.

The Competitive On-Chield Yield Landscape:

*Implied via USDY trading at a premium (~$1.11) to its net asset value.

Evidence of Capital Migration:

1. Institutional-Grade RWA Growth: Ondo Finance's TVL has held steady in the $2.2B - $2.4B range from August 2025 through February 2026, demonstrating resilient institutional demand for its tokenized Treasury product despite market volatility. TokenTerminal
2. CEX-Owned Capital Moving On-Chain: Coinbase's on-chain capital on Base, tracked via Morpho, shows ~$1.87B in collateral supporting ~$1.02B in active debt as of early 2026. Dune This is not retail money seeking yield; this is the exchange's own ecosystem capital and that of its advanced users operating in a transparent, on-chain lending market. The cbBTC/USDC pool dominates ($1.8B collateral), illustrating deep on-chain liquidity formation.
3. Yield Gap Argument: A retail or institutional holder comparing a 2% flexible CeFi yield to a 4-7.36% yield on Sky (backed by overcollateralized crypto assets) or a ~4% implied yield on Ondo USDY (backed by direct T-bill claims) faces a clear economic choice. The transparency and self-custody of DeFi/RWA become compelling at a 2-5x yield premium.

This diversion weakens CEX pricing power: To compete for large, yield-sensitive capital, CEXs would need to raise rates, increasing their subsidy cost. Instead, they appear to be segmenting the market, ceding high-yield seekers to on-chain alternatives while serving users who prioritize convenience and liquidity over maximum return.

5. Data Validation & Future Trend Forecasting

Validating the Thesis with Key Cross-Market Metrics:

1. Futures Open Interest (OI) Stability: Despite price fluctuations, aggregate BTC OI has remained anchored around $43-44B, and ETH OI around $23-24B. Coinglass This confirms the absence of a new leverage expansion cycle that would drive borrowing demand and yields higher.
2. DeFi Stablecoin TVL Dominance & CEX On-Chain Activity: The significant and growing TVL in DeFi-native stablecoin yield protocols (Sky's SSR TVL at $4B, stUSDS at $154M) versus the stagnation of CeFi yields demonstrates a product-market fit shift. Sky.money The $1.87B in Coinbase-linked collateral on Morpho is a canonical data point proving the diversion is not theoretical but operational. Dune
3. Historical Rate Compression: The descent from widespread 10-22% promotional APYs in late 2024/early 2025 to a current ceiling of ~6% for top-tier locked products (with flexible rates often at 1-3%) is the most direct validation of the trend. CoinMarketCap

Forecast: Evolution Over the Next 6-12 Months (Assuming Stable Macro) We project the continuation of current trends, leading to a bifurcated and specialized yield market:

• CeFi Yield Products will further evolve into:
  • Liquidity-First Utility Yields: Low, flexible rates (0.5-3%) designed not to attract yield farmers but to provide minimal return on idle trading capital.
  • Structured Products & Bundles: Locked staking terms bundled with fee discounts, NFT access, or airdrop eligibility—yield as part of a loyalty/value-add package, not a standalone product.
  • Deeper RWA Integration: CEXs like Coinbase may begin offering direct access to tokenized Treasury products (e.g., Ondo USDY) on their platforms, effectively becoming distributors for on-chain yield, capturing fee revenue while offloading yield generation.
• DeFi/RWA Yields will become the default for institutional and yield-optimizing capital, with rates continuing to reflect on-chain supply/demand and TradFi benchmark rates. Regulatory clarity will further accelerate this inflow.

Conclusion & Actionable Asset Allocation Advice

The decline in CEX stablecoin yields is structural, not cyclical. It results from the convergence of normalized TradFi rates, subdued leverage demand, post-regulatory business model shifts, and competitive pressure from transparent on-chain alternatives. A return to the double-digit subsidy era is highly improbable.

Allocation Strategies by Investor Profile:

Final Note: The yield compression marks a healthy maturation. Yield is no longer a cheap marketing tool but is being priced by genuine market forces—both traditional and crypto-native. The strategic imperative for capital allocators is to recognize this new landscape and align their stablecoin deployment with their true objectives: utility liquidity or optimized return.