LP Tokens vs Single-Asset Tokens in Vault Design

Maximizes yield from existing liquidity: Leverages concentrated liquidity positions (e.g., Uniswap V3) and fee compounding. Protocols like Gamma and Arrakis can boost APY by 2-5x versus passive LPing. This matters for protocols targeting sophisticated LPs and maximizing TVL.

Introduces concentrated loss management: Vaults must actively manage price ranges and rebalance, adding smart contract and strategy risk. A failed rebalance can lead to 100% idle capital. This matters for protocols where security and simplicity are paramount over raw yield.

Eliminates impermanent loss (IL): Users deposit a single asset (e.g., ETH) and receive a yield-bearing token (e.g., stETH, Aave's aToken). TVL leaders like Lido ($30B+) prove the demand for IL-free yield. This matters for onboarding mainstream users and stablecoin-focused protocols.

Yield is capped by lending/staking rates: Relies on underlying money markets (Aave, Compound) or consensus-layer staking. APYs are typically lower (3-8%) versus LP strategies. This matters for protocols competing in high-yield niches or needing to bootstrap liquidity from scratch.

Dual utility from a single deposit: LP tokens represent a claim on two (or more) underlying assets, allowing users to collateralize a basket while it earns fees. This enables leveraged yield farming strategies (e.g., deposit LP token, borrow stablecoin, re-add liquidity). Protocols like Aave and Compound have seen vaults with 60-80% LTV ratios for major pairs.

Vulnerable to multi-dimensional risk: Collateral value depends on impermanent loss dynamics and the accuracy of TWAP oracles (e.g., Chainlink, Uniswap Oracles). A sharp price divergence can trigger liquidations even if the pooled dollar value is stable. Requires sophisticated risk models, as seen in Euler Finance's isolation-mode approach for volatile pairs.

Predictable risk modeling: Collateral value is tied to a single price feed, simplifying liquidation logic and reducing oracle failure points. This is preferred for stablecoin-heavy protocols (MakerDAO's DAI, Liquity's LUSD) and institutional vaults where risk must be compartmentalized. Enables higher LTVs (e.g., 90%+ for stETH) due to clearer volatility profiles.

Idle capital problem: Depositing a single asset (e.g., ETH) as collateral prevents it from being deployed in yield-generating DeFi strategies elsewhere. This creates a significant opportunity cost for sophisticated users, making such vaults less attractive compared to yield-bearing collateral types like staked assets or LP tokens in protocols like Benqi or Radiant.

Maximizes utility of locked assets: A single ETH-USDC Uniswap v3 LP token can be used for both yield farming and collateralization simultaneously. This matters for protocols like Aave or Compound seeking to boost TVL without requiring additional user deposits, effectively creating a leveraged yield position.

Exposes vaults to multiple failure modes: Impermanent loss, DEX pool exploit (e.g., Curve vulnerability), and oracle manipulation (e.g., TWAP attacks). This matters for risk-averse protocols like MakerDAO, which historically avoided LP tokens due to the difficulty in modeling correlated asset de-pegging.

Isolates collateral risk to one asset: Valuing stETH or rETH collateral only requires monitoring the underlying asset's price and the staking derivative's peg. This matters for institutional vaults and conservative money markets like Maple Finance, where clear, auditable risk parameters are non-negotiable.

Forgoes composable yield opportunities: Holding plain ETH as collateral earns nothing, whereas an LP token generates fees. This matters for yield-optimizing protocols like Yearn Finance, where vault strategies are built around maximizing returns from collateral assets, making single-asset deposits a capital efficiency loss.