Author: Jae, PANews
The end of a cycle often begins with the smallest indicators.
Since September 2025, the DeFi (Decentralized Finance) market has entered a “interest rate winter.” The average annual percentage yield (APY) for mainstream stablecoins in leading lending protocols has fallen to its lowest level since June 2023.
On the Ethereum mainnet’s Aave V3, deposit rates for USDC and USDT have dropped below 2%. Meanwhile, the yield on the 10-year U.S. Treasury bond has risen back to 4.24%. For DeFi players who experienced the DeFi Summer and are accustomed to high APYs, this is not just a numerical decline but a death knell signaling the end of a cycle.
Is this simply a cyclical fluctuation, or is the market undergoing a structural reshaping?
Supply and demand mismatch, liquidity overload causing interest rate collapse
Over the past six months, the interest rate curves of major lending protocols have been trending downward, experiencing a yield contraction driven by an oversupply of capital.
Interest rates are the price of capital. The physical basis for setting this price is the supply of capital.
Since 2024, the stablecoin sector has experienced an unprecedented “expansion wave,” with total market cap soaring from less than $130 billion to over $310 billion, with a compound annual growth rate of about 55%.
The problem is that the surge in supply has not been matched by a proportional increase in on-chain demand.
When the supply of a certain asset (liquidity of stablecoins) increases significantly while demand remains weak, its price (interest rate) must fall. This is a fundamental economic principle, and DeFi is no exception.
Take Aave, a leading lending platform, as an example. Its stablecoin utilization rate is declining sharply. As of March 12, the total value locked (TVL) in Aave reached $42.5 billion.
Digging into the capital structure reveals an unsettling figure: active loans amount to only $16.3 billion. Over 60% of deposited assets are idle. This supply-demand imbalance directly causes interest rates to plummet.
This means funds are deposited but not borrowed, leading to severe liquidity congestion. Protocol algorithms are forced to automatically lower interest rates in an attempt to attract more borrowers.
However, these efforts have yielded little success. On Aave V3, the base rates for USDC and USDT on Ethereum have already fallen below 2%, starkly contrasting with the double-digit returns typical during the bull market.
The stablecoin market has fallen into a “liquidity trap.” When the market is flooded with low-cost funds but lacks high-yield investment opportunities, these funds pile up in lending pools.
Collapse of funding rates, cooling of cycle lending causing leverage to stall
The prosperity of stablecoin interest rates in DeFi is fundamentally driven by “leverage.” When arbitrage activity in perpetual futures markets cools, demand for stablecoin lending rapidly shrinks, causing rates to plunge.
In a bull market, bullish sentiment drives funding rates positive and high. Arbitrageurs hedge risk by “borrowing stablecoins to buy spot + selling perpetual contracts,” earning funding fees through a delta-neutral strategy. In this process, stablecoins serve as fuel.
However, recent derivatives market performance has been sluggish. On major centralized exchanges (CEX), funding rates for BTC and ETH have repeatedly turned negative or remained very low positive. This indicates that short positions dominate or that longs are extremely cautious.
Regardless of the explanation, the result is the same: arbitrageurs lack motivation.
When annualized funding rates decline sharply, considering borrowing costs and trading fees, net profits for arbitrageurs are significantly reduced. Their demand for borrowing stablecoins drops off a cliff.
Another major source of stablecoin lending demand is cycle lending. This profit-enhancing strategy typically involves: depositing yield-bearing assets like sUSDe in Aave, borrowing USDC, then swapping the borrowed USDC for more sUSDe and depositing again.
This strategy was once very popular because USDe yields reached as high as 30%, while borrowing costs were around 10%, leaving a 20 percentage point arbitrage margin.
However, after the “1011” event, the interest spread narrowed catastrophically, and USDe faced a scalability ceiling, shrinking from nearly $15 billion to the current $6 billion.
The yield of USDe heavily depends on the size of short positions in the market. Since the total open interest in perpetual markets is limited, as USDe expands to a certain scale, the required short positions for hedging will itself lower the overall market funding rates, further suppressing sUSDe yields.
For ordinary traders, declining sUSDe yields reduce their strategy margins. Their decreased demand for leveraged positions further diminishes their need for stablecoin collateral.
This creates a self-reinforcing negative cycle: demand shrinks → rates fall → demand shrinks further.
Shifts in crypto market risk appetite, funds seeking more certainty
The overall decline in risk appetite in the crypto market is another key factor driving stablecoin rates lower.
Over the past month, the Crypto Fear & Greed Index has frequently hit “extreme fear” levels, even when BTC prices hovered around $70,000, with no sustained improvement in sentiment.
Data from CoinDesk shows that in February, total trading volume on CEXs fell by 2.41%, down to $5.61 trillion, the lowest since October 2024.
Decreased risk appetite has prompted investors to shift toward more certain market segments.
Since January 2024, the effective federal funds rate in the U.S. has remained above 3.6%. Although markets expect a gradual easing of monetary policy, the actual interest rates remain relatively high.
This macro environment also exerts a profound downward pressure on DeFi stablecoin interest rates. When risk-free U.S. Treasury yields are higher than DeFi deposit rates, rational investors will withdraw funds from on-chain protocols or shift into RWA (Real World Asset)-backed protocols without risk premium compensation.
During this interest rate winter, not all protocols are shrinking. Sky (formerly MakerDAO) has built a unique “yield moat.”
Compared to Aave, which relies more on on-chain lending demand, Sky’s yields also come from $1.5 billion in mature RWA assets, including U.S. Treasuries and AAA corporate debt, which are unaffected by crypto market volatility and provide stable cash flows.
This model of converting RWA into collateral has driven USDS supply to grow 68% year-over-year monthly, with a market cap approaching $8 billion.
Currently, the yield on sUSDS remains around 3.75%, serving as a “floor” for on-chain yields. Deposits in USDC and USDT treasuries can yield over 5%.
This positions Sky as a sort of “benchmark rate platform.” In contrast, similar assets on Aave offer rates that are hardly competitive.
Thus, Sky is transforming from a simple stablecoin protocol into a “fixed income asset management” platform, leveraging its large RWA portfolio to hedge against crypto market downturns. When DeFi demand wanes internally, it can seek returns externally (in traditional finance).
For investors, learning to analyze whether yields are backed by government bond dividends or by volatility premiums from futures markets will be a crucial skill in this cycle. Strategies will need to shift from “chasing APY” to “seeking differentiated risk exposure.”
The “interest rate winter” is not only a cyclical fluctuation but also an inevitable pain point in DeFi’s “bubble deflation.”
Perhaps, just as the lows of 2023 set the stage for the prosperity of 2024, this interest rate bottoming may also be DeFi’s way of accumulating energy for the next leap.
