Intro to Yield Token Compounding

Intro to Yield Token Compounding

Leverage without lending

If you’ve used DeFi, you’re probably familiar with the pattern of locking up assets to earn yield.

This simple pattern is foundational to DeFi and has made total value locked (TVL) the industry’s north star.

However, these big TVL numbers also represent massive capital inefficiency. The productivity of those assets is limited to a singular revenue opportunity — one vault, one validator, one strategy.

But it doesn’t have to be that way, not anymore.

Element lets you put otherwise locked assets to work beyond the vault while still earning APYs.

Incidentally, Element also allows you to double down on vaults where you have high conviction.

Today, we’re diving into a powerful source of leverage enabled by Element called Yield Token Compounding (YTC).

YTC allows you to multiply your yield exposure without borrowing any additional assets.

Let’s get started!

Splitting the asset

First, let’s define “yield token” and some other stuff, then we’ll get into “compounding.”

A yield token (YT) represents the variable yield gain over a term for a locked base asset. Importantly, a yield token does not represent the locked base asset itself, only the yield.

The locked base asset is represented as a separate token called a principal token (PT).

Yield tokens and principal tokens are always minted together but are totally separate tokens. When you deposit, the minted tokens are always associated with a common term and APY, for example, 3 months and 10% APY.

So let’s say you deposit some ETH into Element and receive newly minted ptETH and ytETH.

You can now control the principal and yield as two distinct tokens, PT and YT.

Element Pools

Next, let’s say you decide to immediately sell your PT but hold your YT.

Where do you sell it? Element Pools!

Element pools are decentralized, liquid markets where you can simply trade PTs or YTs for their base asset, in this case, ETH.

These pools use custom pricing curves designed for handling assets with yields and terms, which are usually not relevant for AMMs. You can read more about the technical details of Element Pools here.

The cost of flexibility

Keep in mind, when trading a PT for its base asset, you will always receive marginally less base asset than you originally deposited for minting the PT. This market-driven discount makes up for the buyer’s opportunity cost of holding the PT to term for the full value (e.g., 1 ETH = .9 ptETH at 0 days matured).

Remember, the base asset is still locked somewhere to generate yield for the YT, so you’re selling the PT for slightly less than face value to someone who’s willing to wait. Think of it as the cost of time and flexibility.

The promised land

Now that some risk-averse casual bought your locked ETH, your impatient ass can ape around with a big chunk of your original ETH balance and still keep your APY.

You can do anything with your new ETH.

You could buy an NFT or mint some DAI.

But what if you just want more yield?

Well, fren, whether you realize it or not, you’re on the cusp of completing your first compounding cycle with Element.

Welcome to Yield Token Compounding.

Yield compounding cycles

Let’s quickly recap what just happened because it’s also what comes next.

  1. You deposit ETH into Element, receiving ptETH and ytETH.
  2. You hold your ytETH, earning yield on the ETH.
  3. You sell your ptETH at a discount, receiving ETH.
  4. You want more yield on your ETH.
  5. Repeat.

Let’s try a more practical example.

You deposit 10 ETH into Element and want maximum yield from your favorite vault.

“Crush my ETH into yield!”, you say.

You’re getting a 20% variable APY on ytETH and lose 10% of your ETH every cycle from selling ptETH at a discount so you can re-enter the vault with vanilla ETH.

The chart below illustrates what that looks like after nine cycles.

It’s almost hard to believe.

After just one cycle, you’ve nearly doubled your exposure.

After eight cycles, you’re earning >60 ETH worth of yield.

You never borrowed any ETH to do it.

You just helped some casuals be casual, and they helped you ape.

Who’da thought?

Element Finance does not loan or provide leverage. If a user wishes to gain leverage, they do so with their own funds and at their own risk.

Keep an eye out for our upcoming post where we cover advanced YTC techniques and walk through the specific steps in the UI.

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