Yield Stripping

A trader uses yield stripping to maximize capital efficiency. For example, they might deposit wrapped staked ETH (wstETH) into a protocol like Aura Finance or Convex Finance to receive auraBAL or cvxCRV tokens. These tokens represent a claim on future yield. The trader can then sell these yield tokens on the open market for immediate capital, which is redeployed into the underlying vault to compound positions, effectively creating leverage.

Yield stripping creates pure speculative instruments. A user bullish on future Curve (CRV) emissions but bearish on the CRV token price can strip the yield from a Curve LP token. They sell the yield-bearing component (e.g., a claim on CRV rewards) to lock in a dollar value for future emissions, while retaining the principal LP token. This allows for isolated bets on protocol emissions versus token price appreciation.

Institutional and retail users utilize stripped yield tokens to create synthetic fixed-income products. By selling the volatile Yield Token, a holder of a yield-bearing asset can lock in a known, fixed return on their principal, transforming variable DeFi APY into a predictable cash flow. The buyer of the Yield Token assumes the volatility risk for potentially higher returns, analogous to trading interest rate futures.

DAO treasuries holding large positions of their own governance tokens (e.g., UNI, AAVE) can engage in yield stripping to generate protocol-owned liquidity without selling the underlying asset. By depositing tokens into a liquidity pool and stripping the future LP rewards, the DAO can sell the yield stream for upfront capital (e.g., stablecoins) to fund operations, while the principal tokens remain locked, maintaining voting power and long-term alignment.

Traders exploit pricing inefficiencies between the Principal Token and Yield Token and their combined underlying asset. If the sum of the market prices of PT + YT is less than the price of the redeemable underlying asset, an arbitrageur can buy the tokens, merge them, and redeem the asset for a risk-free profit. This activity helps maintain market efficiency and peg stability for yield-stripping protocols.

Yield stripping dramatically increases capital efficiency by allowing investors to access the cash flow of an asset without tying up capital in the underlying principal. This creates two liquid markets: one for principal tokens (e.g., zero-coupon bonds) and one for yield tokens (pure income streams). Investors can sell the principal to free up capital while retaining exposure to future yield, or vice-versa, optimizing their portfolio allocation.

The technique enables precise risk tranching. Investors can choose their exposure:

• Yield-Only (High Risk/Return): Hold the yield token for leveraged income exposure, bearing the full risk of yield fluctuations.
• Principal-Only (Lower Risk): Hold the principal token, which behaves like a discounted asset, insulated from variable yield rates. This allows for the creation of tailored financial products that meet specific investor appetites, from conservative to highly speculative.

Stripped yield tokens become primitive building blocks ("money legos") within DeFi. These pure yield streams can be:

• Used as collateral in lending protocols.
• Bundled into yield aggregators or index products.
• Traded on decentralized exchanges (DEXs) as a standalone asset class. This composability unlocks innovative strategies like yield trading and the creation of structured products directly on-chain.

For Real-World Assets like bonds or real estate, yield stripping is a foundational mechanism. It allows the cash flow from an illiquid RWA (e.g., bond coupons, rental income) to be tokenized and sold separately from the ownership claim. This facilitates:

• Fractional ownership of high-value assets.
• Broader, global investor access to institutional-grade yield.
• Secondary markets for income streams, increasing overall market liquidity for RWAs.

The separation provides powerful hedging tools. Institutions and DAOs can:

• Hedge interest rate risk by taking opposing positions in principal and yield tokens.
• Isolate and hedge specific risks (e.g., default risk on the principal vs. yield volatility).
• Execute more precise duration-matching strategies for liabilities. This granular risk management is a significant advancement over traditional, bundled asset frameworks.

By creating distinct markets for yield and principal, yield stripping improves price discovery for both components. The market-determined price of a yield token reflects pure expectations of future income, free from principal value noise. This leads to:

• More accurate pricing of credit risk and future cash flows.
• Efficient arbitrage opportunities between the stripped components and the whole asset.
• Transparent, real-time signals on the cost of yield within the financial system.

The foundational mechanism of yield stripping, where a single yield-bearing asset (e.g., a bond or staked ETH) is split into two distinct tokens: a Principal Token (PT) representing the underlying asset's face value at maturity, and an Interest Token (YT) representing the right to all future yield. This separation allows each component to be traded independently on secondary markets.

Yield stripping creates a clear division between predictable and speculative returns. The Principal Token (PT) becomes a zero-coupon, fixed-income instrument, often trading at a discount. The Interest Token (YT) is a leveraged play on the underlying asset's variable yield, whose value accrues over time but decays to zero at maturity.

A derivative token that grants the holder the right to claim all future yield generated by the underlying asset until a specified maturity date. Key characteristics include:

• Yield Accrual: Value increases as yield is generated.
• Time Decay: Its value approaches zero as maturity nears.
• Leveraged Exposure: Provides amplified exposure to yield rate fluctuations compared to holding the base asset.

A token representing a claim on the principal (or face value) of the underlying asset, redeemable at maturity. It functions as a zero-coupon bond, typically trading at a discount to its redemption value. Investors use PTs for:

• Capital preservation with a known future payout.
• Speculating on changes in discount rates.
• Hedging against yield volatility captured by the YT.

The foundational collateral that enables yield stripping. Common examples in DeFi include:

• Liquid Staking Tokens (LSTs) like stETH or rETH.
• Money Market Deposit Tokens like cDAI or aUSDC.
• Governance Staking Tokens that emit protocol fees.
• Real-World Asset (RWA) tokens representing bonds or treasuries. The asset's yield generation is the 'raw material' for the strategy.

The separation of yield and principal enables sophisticated financial maneuvers. Common strategies include:

• Yield Speculation: Buying YTs to bet on rising yield rates.
• Fixed Yield Locks: Selling YTs to lock in a fixed return while holding the PT.
• Basis Trading: Arbitraging price discrepancies between the underlying asset and the PT/YT bundle.
• Structured Products: Using PTs and YTs as building blocks for more complex derivative instruments.