Fed Decision Outlook: How US Interest Rates Affect the Stablecoin Industry?

This article focuses on fiat-collateralized USD stablecoins (such as USDT and USDC), adopting a global perspective to explore how the Fed's interest rate cycle and other potential risks will reshape the industry landscape.

Written by: 0xYYcn Yiran, Bitfox Research

The market size and importance of stablecoins continue to soar, driven by the enthusiasm of the cryptocurrency market and the expansion of mainstream application scenarios. By mid-2025, its total market value has exceeded 250 billion USD, a growth of over 22% since the beginning of the year. A Morgan Stanley report shows that these tokens pegged to the USD currently have a daily trading volume exceeding 100 billion USD, and will drive a total on-chain transaction volume of up to 27.6 trillion USD in 2024. According to Nasdaq data, this trading scale has surpassed the combined total of Visa and Mastercard. However, behind this prosperous scene lies a series of hidden risks, among which the commercial models of issuers and the stability of their tokens are particularly critical, closely tied to changes in the US interest rates. As the next decision by the Federal Open Market Committee (FOMC) approaches, this study focuses on fiat-collateralized USD stablecoins (such as USDT and USDC) from a global perspective, exploring how the Fed's interest rate cycle and other potential risks will reshape the industry landscape.

Stablecoin 101: Growing Amidst Hype and Regulation

Definition of stablecoin:

Stablecoins are a type of cryptocurrency designed to maintain a constant value, with each token typically pegged to the US dollar at a 1:1 ratio. Their value stabilization mechanisms are primarily achieved through two methods: backing by sufficient reserve assets (such as cash and short-term securities) or relying on specific algorithms to regulate token supply. Fiat-collateralized stablecoins, represented by Tether (USDT) and Circle (USDC), provide complete collateral backing for each unit of token issued by holding cash and short-term securities. This collateral mechanism is central to their price stability. According to data from the Atlantic Council, approximately 99% of the circulating supply of stablecoins is dominated by USD-denominated types.

Industry Significance and Current Situation:

In 2025, stablecoins are leaping out of the confines of the crypto space, accelerating their integration into mainstream financial and commercial scenarios. The international payment giant Visa has launched a platform supporting banks to issue stablecoins, while Stripe has integrated stablecoin payment features, and Amazon and Walmart are also brewing their own stablecoins. Meanwhile, the global regulatory framework is taking shape. In June 2025, the U.S. Senate passed the landmark "Stablecoin Payment Clarity Act" (GENIUS Act), becoming the first federal-level stablecoin regulatory law; its core requirements include: issuers must maintain a stable 1:1 backing ratio with high-quality liquid assets (cash or short-term government bonds maturing within three months) and clearly define the rights protection obligations of token holders. In the transatlantic European market, the "Regulation on Markets in Crypto-Assets" (MiCA) framework implements stricter regulations, granting authorities the power to restrict the circulation of non-euro stablecoins when they threaten the monetary stability of the eurozone. At the market level, stablecoins demonstrate strong growth momentum: as of June 2025, their total circulation value has exceeded $255 billion. Citigroup predicts that the market size is expected to surge to $1.6 trillion before 2030, achieving approximately sevenfold growth. This clearly indicates that stablecoins are moving towards mainstream adoption, but their rapid growth is also accompanied by new risks and frictions.

Figure 1: Comparison of Ethereum stablecoin adoption and market activity analysis (past 30 days)

Fiat Supports Stablecoin and Interest Rate Sensitive Model

Unlike traditional bank deposits that provide interest to customers, stablecoin holders typically do not enjoy any returns. According to the GENIUS Act, the account balances of fiat-collateralized USD stablecoin users are explicitly set to a zero-interest status (0%). This regulatory arrangement allows issuers to retain all the returns generated from the reserves' investments. In the current environment of high interest rates, this mechanism has prompted companies such as Tether and Circle (the issuer of USD Coin) to transform into high-profit entities. However, this model also exposes them to significant vulnerability during periods of declining interest rates.

Reserve Investment Structure:

To ensure liquidity and maintain the peg value of stablecoins, major issuers allocate the majority of their reserves to short-term U.S. Treasury bills and other short-term financial instruments. As of early 2025, Tether holds U.S. government debt amounting to between 113 billion and 120 billion USD, accounting for about 80% of its total reserves, making it one of the top 20 holders of U.S. Treasury bonds globally. The chart below shows the detailed composition of Tether's reserve asset allocation, clearly indicating that its assets are highly concentrated in government bonds and cash-like assets, while other securities, gold, and non-traditional assets such as Bitcoin occupy a significantly lower proportion in the asset portfolio.

Figure 2 Tether's reserve asset composition in 2025 (mainly U.S. Treasury bonds), reflecting the high dependence of fiat-backed stablecoins on interest-bearing government assets

High-quality reserve assets not only maintain peg value and enhance user confidence, but also generate substantial interest income— the lifeline of the current stablecoin business model. Between 2022 and 2023, the Fed's aggressive interest rate hike policy pushed yields on short-term Treasury bills (T-bills) and bank deposit rates to multi-year highs, directly amplifying the investment returns of stablecoin reserves. For example, according to the financial report disclosed by Circle, out of a total revenue of $1.68 billion in 2024, as much as $1.67 billion (accounting for 99%) came from interest income on reserve assets. On the other hand, Techxplore reported that Tether's profits in 2024 were reported to reach $13 billion, rivaling or surpassing the earnings scale of top Wall Street banks like Goldman Sachs. Such profit scales (created by Tether's operational team of about 100 people) particularly highlight the strong boosting effect of the high-interest rate environment on stablecoin issuers' income. Essentially, stablecoin issuers operate a high-return 'Carry Trade', allocating user funds to Treasury assets yielding over 5%, and fully capturing that interest spread because users accept zero interest rates. This results in vulnerability to interest rate fluctuations.

Interest Rate Volatility Risk Exposure

The revenue model of stablecoin issuers is highly sensitive to changes in the Fed's interest rates. For example, a mere 50 basis point rate cut (0.50%) could lead to a sharp decline in Tether's annual interest income by approximately $600 million. As warned by Nasdaq analysis institutions: "An over-reliance on interest income will leave issuers like Circle in a vulnerable position during a rate-cutting cycle."

The following Figure 3 shows the Federal Funds Interest Rate curve drawn by the Chicago Mercantile Exchange (CME) based on market expectations as of July 23, 2025 (forecast period until the end of 2026); Figure 4 elaborates on the impact mechanism of interest rate changes on Circle's reserve earnings through quantitative analysis at the million-dollar level.

Figure 3 Federal Funds Rate Outlook for December 2026 (CME, 2025/07/23)

Figure 4 Circle Reserve Income Sensitivity to Interest Rate Changes

Taking 2024 as an example, Circle's reserve asset interest income reached $1.67 billion, accounting for 99% of its total revenue ($1.68 billion). Based on the Chicago Mercantile Exchange (CME) data model (as of July 23, 2025), if the federal funds rate falls back to the range of 2.25%–2.50% in December 2026 (with a probability of about 90%), Circle expects to lose approximately $882 million in interest income, which exceeds 50% of its relevant total income for 2024. To make up for this income gap, the company must double its USDC stablecoin circulation supply by the end of 2026.

Other Core Risks Beyond Interest Rate: Multiple Challenges of the Stablecoin System

Although interest rate dynamics play a central role in the stablecoin industry, there are still various other key risks and challenges within the system. In the context of widespread optimism in the industry, there is an urgent need to systematically summarize these risk factors to provide a calm and comprehensive analysis:

Regulatory and Legal Uncertainty

The operation of stablecoins is currently constrained by fragmented regulatory frameworks such as the U.S. "Stablecoin Payment Transparency Act" (GENIUS Act) and the EU "Regulation on Markets in Crypto-Assets" (MiCA). While this framework grants legitimacy to some issuers, it also brings high compliance costs and sudden market entry restrictions. Regulators impose mandatory measures for insufficient transparency of reserves, evasion of sanctions (such as Tether's involvement in billions of dollars in transactions in sanctioned regions), or violations of consumer rights, which can quickly lead to the suspension of redemption functions for specific stablecoins or their expulsion from core markets.

Bank Cooperation and Liquidity Concentration Risk

The reserve custody and fiat channel (deposit/withdrawal) services for fiat-collateralized stablecoins heavily rely on a limited number of partner banks. Sudden crises at partner banks (such as the collapse of Silicon Valley Bank (SVB) that led to the freezing of $3.3 billion in USDC reserves) or large-scale concentrated redemption waves can quickly deplete bank deposit reserves, triggering token decoupling, and when wholesale redemption pressures breach the bank's cash buffers, threaten the liquidity stability of the broader banking system.

Anchor Stability and De-pegging Risk

Even when claiming full collateralization, stablecoins may still experience and have actually experienced peg mechanism collapses when market confidence wavers (for example, in March 2023, USDC's price plummeted to $0.88 due to concerns over the accessibility of reserve assets). The robustness curve of algorithmic stablecoins is even steeper, as evidenced by the collapse of TerraUSD (UST) in 2022.

Transparency and Counterparty Risk

Users rely on the reserve proof reports (Attestations) issued by publishers (usually quarterly) to assess the authenticity and liquidity of assets. However, the lack of comprehensive public audits raises doubts about credibility. Whether it's cash held in banks, shares of money market funds, or assets from repurchase agreements, reserve assets carry counterparty risk and credit risk, which can materially impair the ability to redeem under stressed scenarios.

Operational and Technical Security Risks

Centralized stablecoins can freeze or confiscate tokens to respond to attacks, but they also bring single point governance risks; the DeFi version is susceptible to threats such as smart contract vulnerabilities, cross-chain bridge attacks, and hacking of custodial institutions. At the same time, user operational errors, phishing, and the irreversibility of blockchain transactions also pose daily security challenges to coin holders.

Macroeconomic Financial Stability Risks

Hundreds of billions of dollars in stablecoin reserves are concentrated in the short-term U.S. Treasury market, and large-scale redemptions will directly affect the demand structure for Treasury bonds and the volatility of yields. Extreme outflow scenarios could trigger panic selling (Fire-sales) in the Treasury market; meanwhile, the widespread dollarization of stablecoins may weaken the transmission effectiveness of Fed monetary policy, thereby accelerating the development of Central Bank Digital Currency (CBDC) or the establishment of stricter regulatory barriers.

Conclusion

As the next meeting of the Federal Open Market Committee (FOMC) approaches, the market generally expects interest rates to remain unchanged, but the upcoming meeting minutes and forward guidance will become the focus of attention. The significant growth of fiat-collateralized stablecoins such as USDT and USDC masks the nature of their business model, which is deeply tied to changes in US interest rates. Looking ahead, even a moderate rate cut (for example, 25-50 basis points) could erode hundreds of millions in interest income, forcing issuers to reassess their growth paths or to share some of their profits with coin holders to maintain market adoption.

In addition to interest rate sensitivity, stablecoins must also contend with an evolving regulatory environment, risks associated with bank and liquidity concentration, challenges to peg integrity, and operational hazards ranging from smart contract vulnerabilities to insufficient reserve transparency. Crucially, when such tokens become a systemically important holder of short-term US Treasury bonds, their redemption behavior may impact the pricing mechanisms of the global bond market and disrupt the transmission pathways of monetary policy effectiveness.