Yield tokenization

Bond markets have long separated a bond's principal from its interest payments and sold them as different products. Yield tokenization brings the same idea to DeFi. Take a token that earns a variable yield, split it into the right to the principal and the right to the yield, and let each trade on its own.

How it works

A yield-bearing token, often a vault token, is placed into a yield tokenization protocol, which issues two tokens with the same maturity date:

• A principal token (PT), which can be exchanged for the underlying asset at maturity.
• A yield token (YT), which collects all the yield the underlying asset earns until maturity, then stops.

One PT plus one YT together equal the original position. Pendle is a widely used protocol built on this design, with markets where each part can be bought and sold.

Where the fixed rate comes from

A PT trades at a discount before maturity, because its holder gives up the yield in the meantime. Buying it at that discount and holding it to maturity produces a return that is known on the day of purchase, as long as the underlying asset holds its value. That is why PTs are described as a fixed-rate position. The YT is the mirror image, a leveraged position on future yield. If the yield turns out higher than the market expected, YT holders gain; if lower, they lose. Either way the YT is worth nothing at maturity.

A worked example

Suppose a dollar vault token earns a variable yield, and its PT with one year to maturity trades at 0.95 of the underlying. A buyer pays 950 dollars for PTs that can be exchanged for 1,000 dollars of the underlying in a year, about 50 dollars of return set on the day of purchase. A YT buyer pays roughly 50 dollars for the yield on 1,000 dollars of the underlying over the same year. If the yield actually comes to 70 dollars, the YT buyer comes out ahead; if it comes to 30, they lose. The PT buyer receives the same 1,000 dollars either way.

Why it is useful

Yield tokenization gives a variable yield a market price. Holders who want certainty can lock in a rate, those with a view on rates can trade it, and lending markets can accept PTs as collateral because their value moves toward the underlying as maturity approaches. It is a clear case of composability: the protocol works with any yield-bearing token that behaves predictably, such as one built on ERC-4626.

Risks and limits

• The fixed rate depends on the underlying asset. If the underlying loses value, so does the PT.
• Selling a PT before maturity means accepting the market price, which can be lower than expected if rates rise or liquidity thins.
• YTs lose value as maturity approaches and reach zero at maturity, so a YT holder can lose most of the cost if yield disappoints.
• The protocol adds its own smart contract and oracle risks on top of those of the underlying asset.

A fixed rate built this way is a market price for future yield, not a promise.

Pendle is among Tori Finance's integrations, alongside Morpho and Curve. strUSD, Tori Finance's ERC-4626 vault token, accrues a variable yield, the kind of yield that yield tokenization protocols are built to split and price.