If Tether’s stablecoin USDT were a country, it would be the 20th-largest holder of American government debt, ahead of Australia or Italy, and on par with Germany, the world’s fourth-largest economy. At $83 billion in circulation, and growing, Tether is a global juggernaut, and—perhaps—a too-big-to-fail behemoth that’s become the de facto reserve asset of the crypto economy. Tether’s success in popularizing U.S. dollar-backed stablecoins is somewhat ironic, though: Using a technology designed to disintermediate governments and middlemen from financial transactions, Tether has made the dollar Web3’s first killer app.
Tether has long been the big dog of stablecoins and, in recent years, has only grown in dominance. The token accounts for 68% of the global supply of stablecoins, up from 50% in January. Tether’s total market value is larger now than at the peak of the 2021 bull market.
But it is far from the only player. On Monday, a major financial services company joined the conversation: PayPal announced that it’s finally rolling out its own stablecoin, PYUSD. Like USDT and Circle-owned USDC, which boasts a $20 billion supply of its own, PYUSD will be backed dollar-for-dollar with short-term U.S. government debt and cash.
Stablecoins have proven incredibly lucrative for Tether, so it’s no surprise why PayPal and others might want to enter the market: PayPal is facing stiffer competition in payments and is looking for ways to diversify into higher-margin areas. Stablecoins are a logical fit, and potentially a lucrative one at a time when Tether’s figures suggest that it’s poised to post a bigger profit than Starbucks, Blackrock—and even PayPal itself. The claim can be taken with a grain of salt given that Tether’s operations are notoriously opaque, but, even in light of this, the company is likely making a lot of money. How?
It’s useful to know USDT gets issued, or “minted,” against money deposited with Tether. USDT is a global, frictionless U.S. dollar alternative used widely as a medium of exchange and store of value, and demand has been surging. Tether invests those deposits in government securities often yielding 5% or more. Because USDT holders do not earn interest, the yields Tether earns on its investments are almost pure profit. In banking, this is spread between what’s paid on deposits and what’s earned via lending is known as the net interest margin, or NIM.
When interest rates go up, banks need to set more money aside in case they experience defaults in their loan book, as rising rates often strain borrowers. And eventually, customers demand higher interest on their savings, which squeezes the margins. Tether does not have any of these issues: It only lends to the U.S. government, which is considered risk-free, plus users don’t expect a return.
How long can USDT keep printing money like this? After all, at some point users might want to earn a return on USDT, especially if it’s sitting idly in a wallet as a U.S. dollar savings instrument, which is common in countries like Nigeria and others where the local currency is unstable or the financial sector undeveloped. Could a rival launch a competing interest-bearing centralized stablecoin that simply passes through interest from government securities to holders?
Such a product would differ from the quasi-decentralized stablecoin DAI that pays interest to holders based on yields from lending out the crypto assets it holds as collateral. And certainly, it would bear no similarity to complex and risky “algorithmic stablecoins,” like TerraLuna’s undercollateralized UST, which collapsed last year. What I am suggesting is simple and boring: Let’s call it USDI—”I” for interest payments.
Under this model, holders of USDI would be eligible for the yields on the underlying securities simply by holding it in their wallet of choice. To avoid the kind of duration mismatch of long-term and short-term assets that sunk Silicon Valley Bank, USDI could offer higher yields to holders willing to lock their assets in a smart contract for six months or a year, kind of like an on-chain certificate of deposit, or CD. USDI could retain earnings and become quite profitable while also setting aside reserve funds, all while passing interest payments to holders.
Critics might argue that this product is a solution in search of a problem since U.S. depositors can already hold money in a bank, buy treasuries, or invest in a money-market fund. This ignores the billions of people globally who would be ecstatic to have a way to store value in U.S. dollars while also earning a risk-free return on government securities. Another big hurdle is regulations. To paraphrase the adage “If it walks like a bank and talks like a bank, it’s a bank,” stablecoin issuers would be wading into a new and highly regulated world by offering interest to holders. Also, who’s to say Tether doesn’t just flip a switch and pay out interest itself? Given the potential network effects, that would be hard to compete with.
Then again, companies can’t accomplish much if they give up before trying. On Web3’s economic frontier, everything is possible—and even PayPal appears to be aware of this. Anyone who cares about the future and wants to play a role in shaping it should be watching the stablecoin wars closely.
Alex Tapscott is the author of Web3: Charting the Internet’s Next Economic and Cultural Frontier (Harper Collins, Sept. 19, available for preorder). The opinions expressed in Fortune.com commentary pieces are solely the views of their authors and do not reflect the opinions or beliefs of Fortune.