Coinbase, the most popular retail cryptocurrency exchange in the United States, is offering customers 1.25% interest per year for simply holding USD Coin (USDC) in their accounts.

Essentially, this is similar to banks that offer users an interest rate for holding money in a savings account. Banks generally loan and invest money held in savings accounts, and the interest paid to users comes from the bank’s profits.

Coinbase’s offer also sounds similar to Celsius Network, where users deposit cryptocurrency and earn interest. Celsius Network functions similar to a bank where deposits are used for lending and investing to make profits.

However, Coinbase explicitly declares “Coinbase has no right to use any USDC you hold on Coinbase.” This means that Coinbase is not investing or lending the USD Coins (USDC) deposited by users.

So how is Coinbase paying for this 1.25% annual interest?

First off, it is important to note that Coinbase is a co-founder of CENTRE, which is the organization that created and manages USD Coin (USDC). Therefore, Coinbase has a motivation for making USD Coin (USDC) into the top stablecoin.

At this time, Tether (USDT) is the top stablecoin with a circulating supply of $4.13 billion while USD Coin (USDC) only has a circulating supply of $453,000 million. In other words, Tether (USDT) is an order of magnitude more popular than USD Coin (USDC).

Perhaps Coinbase is offering interest for holding USD Coin (USDC) to increase its circulating supply so it is more competitive with Tether (USDT). Indeed, the annual interest for holding USD Coin (USDC) is a feature that Tether (USDT) does not have. This gives USD Coin (USDC) an advantage. 

Also, Coinbase earns fees when it sells USD Coin (USDC). Apparently, there are no fees when using a bank account, but for a credit or debit card, the fee is 4%. Also, if the USD Coin (USDC) is traded for another cryptocurrency on Coinbase there is a spread fee of 0.5%. So it is possible that Coinbase will earn some of the money for covering the interest payments from selling USD Coin (USDC) and subsequent trading.

Coinbase states that one of the main reasons for this interest program is that it provides an incentive for customers to keep their money on Coinbase rather than withdrawing it to a bank. 

“One of the things we know is a bad customer experience is having to move your money back and forth from Coinbase to a bank account [to] earn a little bit of interest in the bank account,” said Paul Katsen, Coinbase product manager. “We’re trying to bring some of these experiences together but make them crypto-first and on Coinbase.”

Essentially, Coinbase expects increased economic activity on its exchange in general due to customers keeping more money in their accounts. Then the profits earned from the increased activity can be used to pay interest. 

“We can pull from the profits we generate as a business to reward our customers for storing their assets on the platform,” said Max Branzburg, Coinbase director of product. 

A darker theory is that, while Coinbase says it will not use customers’ USD Coin (USDC) for lending or investing, it may use the USD deposited by customers who buy USD Coin (USDC). This is just speculation, though, and would violate USD Coin’s (USDC) promise that every coin is backed by a dollar in the bank. That being said, Tether (USDT) had the same promise in the past, but now Tether (USDT) is apparently backed by all sorts of assets and not just cash in a bank.

Another theory is that Coinbase wants to give people an incentive to buy USD Coin (USDC) on Coinbase, since USD Coin (USDC) is widely available on most exchanges, and people had no incentive to get it from Coinbase.

There are multiple ways Coinbase can profit from giving 1.25% interest per year for holding USD Coin (USDC) without using it for lending or investing. The primary theory explicitly stated by Coinbase is that users will have an incentive to keep more funds on the exchange, increasing economic activity and profits. Also, this will help USD Coin (USDC) better compete with Tether (USDT). 

Whatever the exact reasons for offering interest, and regardless of how exactly this is profitable for Coinbase, Coinbase is one of the most reputable cryptocurrency exchanges, and the 1.25% interest per year for holding USD Coin (USDC) is a new, easy, and safe way to earn money with cryptocurrency.