Yield-Bearing Collateral

These assets perform two functions: collateralization for securing loans and revenue generation through native yield mechanisms. For example, staked ETH (stETH) can be used as collateral to borrow stablecoins, while the underlying ETH continues to accrue staking rewards from the Beacon Chain.

By generating yield, the asset offsets the cost of borrowing (the interest rate) and can improve a position's health. This increases capital efficiency by allowing users to access liquidity without needing to sell their appreciating or income-generating assets. Key metrics like the Loan-to-Value (LTV) ratio must account for the asset's yield profile.

The yield is typically sourced from the underlying protocol's mechanics. Common sources include:

• Staking Rewards: From Proof-of-Stake networks (e.g., stETH, rETH).
• Liquidity Provider (LP) Fees: From Automated Market Makers (e.g., Uniswap v3 LP positions).
• Lending Interest: From supplying assets to money markets (e.g., cTokens, aTokens).

Pricing these assets requires oracles to track both the underlying asset's price and the accrued yield (often reflected as a rebasing balance or exchange rate). Lending protocols must model unique risks, including slashing risk for staked assets, impermanent loss for LP tokens, and smart contract risk of the yield-bearing wrapper.

Leading DeFi lending platforms like Aave, Compound, and MakerDAO have integrated support for various yield-bearing tokens. Implementation varies, with some protocols automatically redirecting yield to repay debt (e.g., Maker's DSR for sDAI) and others allowing users to claim yield separately.

This concept enables complex, automated strategies known as DeFi money legos. For instance, a user can deposit ETH into Lido to receive stETH, use stETH as collateral on Aave to borrow DAI, and then deposit that DAI into a yield farm—creating a layered yield strategy from a single initial asset.

Using yield-bearing collateral introduces unique risks:

• Oracle Complexity: The collateral's value includes both its principal and accrued, unrealized yield, requiring precise price feeds.
• Yield Volatility: Sudden drops in the underlying yield (e.g., staking APR) can reduce the collateral's growth rate and borrowing power.
• Smart Contract Risk: Exposure is multiplied across the staking/protocol and the lending protocol.

This innovation is a major driver of capital efficiency in DeFi. It solves the traditional finance problem of idle collateral. By enabling 'productive collateral,' it allows users to:

• Access liquidity for spending or further investment.
• Construct sophisticated leveraged yield strategies.
• Improve returns on capital by compounding utility.

Yield-bearing collateral is typically a wrapped token (e.g., stETH, aToken) representing a claim on an underlying protocol. This creates a dependency chain where a vulnerability in the yield source (e.g., a staking contract) or the wrapper contract can compromise the collateral's value or its redeemability, leading to undercollateralized loans.

Accurate pricing is complex. Oracles must track both the underlying asset price and the accrued yield. For assets like LP tokens, this requires calculating the value of multiple assets. Manipulating the price feed of the underlying asset or exploiting oracle latency during yield distribution can create arbitrage opportunities that drain lending pools.

The yield component is not stable. A sharp decline in the Annual Percentage Yield (APY) of the underlying asset (e.g., from protocol rewards ending or validator penalties) reduces the effective value of the collateral over time. This can trigger liquidation if the asset's market price doesn't compensate, as the collateral's future income stream is diminished.

Liquidating yield-bearing collateral is more complex than liquidating a simple asset. The liquidator must claim and manage the accrued yield. Protocols may use strategies like:

• Seizing and selling the wrapped token directly.
• Forcing a withdrawal from the yield source (if possible), which may have a delay (e.g., Ethereum staking withdrawals). Poorly designed liquidation can lead to bad debt.

The lending protocol's integration with the yield source is a critical attack surface. Risks include:

• Upgrade risks: The yield protocol upgrades, breaking compatibility.
• Governance attacks: Malicious governance of the yield protocol changes rules, slashing value.
• Slippage & fees: The cost of minting/redeeming the yield token affects liquidation efficiency.

Specific to staking derivatives (e.g., staked ETH). If validators backing the derivative are slashed due to malicious or faulty behavior, the value of the derivative can be programmatically reduced. This non-market devaluation can happen rapidly, potentially before oracle updates or liquidations can occur, directly causing protocol insolvency.