Debt Monetization

The core mechanism where a debt position is represented as a fungible token (NFT or ERC-20). This token, such as an interest-bearing token (ibTKN) or debt NFT, is a claim on the underlying collateral and its accrued obligations. It transforms illiquid credit agreements into standardized, transferable assets that can be traded on secondary markets.

By monetizing debt, locked collateral is made productive. A user can:

• Borrow against an asset and receive a debt token.
• Use that debt token as collateral in another protocol (rehypothecation).
• This creates a leveraged long position or frees up capital for other yield-generating activities, significantly increasing capital efficiency within the DeFi ecosystem.

Debt tokens can be bought and sold on decentralized exchanges (DEXs) or order book markets. This creates a liquid secondary market for debt, allowing:

• Creditors to exit positions before maturity.
• Speculators to take on risk for potential profit.
• Price discovery for credit risk based on market demand, separate from the original lending platform.

Monetization separates credit risk from liquidity risk. The original lender's risk (borrower default) is encoded into the tradable debt token. The buyer of the token assumes this risk, isolating it from the originating protocol. This enables specialized risk markets and allows protocols to offload specific liabilities from their balance sheets.

Standardized debt tokens become new financial primitives that can be integrated across DeFi. They can be used in:

• Yield aggregators and vault strategies.
• As collateral for synthetic asset minting.
• Within structured products and derivatives.
• This composability is a foundational feature, enabling complex, automated financial engineering.

Real-world implementations include:

• MakerDAO's Dai Savings Rate (DSR): sDAI represents a claim on DAI earning the DSR.
• Aave's aTokens & Debt Tokens: aTokens are interest-bearing collateral tokens; variable/stable debt tokens represent borrow positions.
• Compound's cTokens: Accrue interest and are used as collateral.
• Credit Guild's gTokens: Represent non-transferable debt in a lending market.

Yield-bearing collateral refers to assets that accrue interest or rewards while being used as collateral in a CDP. Examples include staked ETH (stETH, rETH) or LP tokens. This allows users to earn yield on their locked assets while simultaneously borrowing against them, a core strategy for maximizing capital efficiency in debt monetization.

Stablecoin minting is the act of generating a decentralized stablecoin (like DAI, LUSD, or crvUSD) by opening a CDP. This is the primary method for creating debt in DeFi. The minted stablecoin can then be deployed into other yield-generating strategies, creating a leveraged yield loop. The stability of the protocol's peg mechanism is critical for this strategy's viability.

Liquidation is the forced sale of a borrower's collateral if their debt position becomes undercollateralized. The Health Factor is a numerical representation of a CDP's safety, calculated as (Collateral Value / Debt Value). If it drops below 1 (or a protocol-specific threshold), the position can be liquidated by keepers to repay the debt, protecting the protocol's solvency.

Recollateralization is the process of adding more collateral or repaying debt to improve the Health Factor of a CDP and avoid liquidation. This is a key risk management action for users engaged in debt monetization strategies, especially in volatile markets where collateral value can drop rapidly.

Leveraged yield farming is a strategy that uses debt monetization to amplify returns. A user:

• Locks collateral to mint a stablecoin.
• Uses the stablecoin to acquire more of the yield-bearing collateral asset.
• Re-locks the new collateral to mint more debt. This cycle increases exposure to the underlying yield, but also multiplicatively increases liquidation risk and gas costs.