Have you ever wondered how banks and financial apps can pay you interest, or where your “APY” is really coming from? Understanding the engine behind your earnings is the first step toward making informed financial decisions.

This guide breaks down three common models for earning a return on your money, explaining how each one works and the specific trade-offs to keep in mind.

Quick Comparison

Feature	Traditional Banks	Fintech Apps	Stablecoin Account
How it Works	Lends out deposits	Acts as a pass-through to banks	Connects lenders & borrowers with code
Typical APY	Low	Moderate	Varies (can be high)
Key Risks	Credit & liquidity risk	Partner bank risk	Smart contract bugs
Transparency	Low (loan details are private)	Medium (you know the partner banks)	High (transactions are public on the blockchain)
Your Control	The bank holds your money	The app and its partner hold your money	Often, you hold your own funds with a private key

1. How Traditional Banks Work

Most of the banks we use every day, such as Bank of America, operate on a system called fractional reserve banking. It might sound complicated, but the idea is pretty simple.

When you deposit money into your savings account, the bank doesn’t let it sit there. They are required to keep a small portion (a “fraction”) of it on hand, but they lend out the rest to other people and businesses.

How you earn interest

When the bank lends out your money, borrowers pay an interest rate. The bank passes a percentage of those earnings back to you as the APY on your savings. The bank’s profit comes from the difference between the interest they earn from borrowers and the interest they pay to savers like you.

Traditional banking has its own unique set of risks:

Credit Risk: This is the risk that the people or businesses who borrowed money from the bank won’t be able to pay it back. Since your deposits are used to fund these loans, widespread defaults could harm the bank’s financial health.

Liquidity Risk: Banks only keep a small fraction of deposits on hand. If a large number of people try to withdraw their money all at once (a “bank run”), the bank may not have enough cash available, causing a crisis.

Interest Rate Risk: If market interest rates go up suddenly, the bank might have to pay more interest on savings accounts than it’s earning from its older, lower-rate loans, squeezing its profits.

The primary safeguard against these risks is typically government insurance. In the U.S., the FDIC insures deposits up to $250,000 per depositor, per bank, which provides a crucial safety net and maintains confidence in the banking system.

2. How Fintech Apps Work

Financial technology (or “fintech”) apps often offer higher APYs than traditional banks. These companies usually aren’t banks themselves but work as a layer on top of existing financial institutions.

How you earn interest

Fintech’s pool money from all their users and deposit it in bulk with partner banks. These are often regional banks willing to pay a higher interest rate to attract large deposits. The fintech app then gives most of that higher interest back to consumers and keeps a small cut for their service.

Fintech apps have their own unique set of risks:

Partner Bank Risk: Your money is often held by a partner bank, not the app itself. This means your funds are exposed to the credit and liquidity risks of a bank you didn’t directly choose.

Intermediary Risk: The app acts as a middleman. If the fintech company faces financial trouble, has a security breach, or shuts down, it could be difficult to access your money at the partner bank.

Data Privacy Risk: Fintech apps collect significant personal and financial data. This creates a risk that your sensitive information could be compromised in a data breach or misused.

Regulated fintechs typically offer “pass-through” FDIC insurance from their partner banks, which means your deposits are still protected up to the federal limit. However, it’s always important to read the fine print and confirm this coverage.

3. How Stablecoin Accounts Work

A newer way to earn interest is through stablecoin lending markets. This approach works a bit differently from banks.

How you earn interest

First, you typically convert your money into stablecoins, which are digital tokens designed to hold a steady value. You then lend these stablecoins out to a lending market. These platforms are run by smart contracts that automatically connect lenders with borrowers. Borrowers pay interest on their loans, and that interest is paid to you as a set rate.

A key feature: Overcollateralization. To reduce the risk of people not paying back loans, these lending markets often require overcollateralization. This means a borrower has to lock up assets that are worth more than the amount they’re borrowing. If they can’t pay back the loan, the platform automatically sells their locked-up assets to pay you back.

Stablecoin lending has its own unique set of risks:

Smart Contract Risk: If there’s a bug or a loophole in the code, it could be exploited by hackers.

Volatility Risk: The assets borrowers lock up as collateral can change in value. If their price drops too quickly, the automatic selling process might not be enough to cover the loan.

Stablecoin Risk: The value of a stablecoin could potentially slip from its 1-to-1 peg.

Overcollateralized markets ensure that a loan is always backed by more value than it is worth. Through an automated process, borrowing can occur without a bank in the middle, typically passing more yield onto the lender.

Closing Thoughts

From your neighborhood bank to a mobile app, there are many ways to earn a return on your money. Each path has its own balance of potential rewards and risks. There’s no single “best” answer. By understanding how each system works, you are better equipped to choose the right path for you.