DeFi has come a long way since the launch of lending protocols such as Compound and Aave. The composable nature of DeFi allows smart contract developers to build on top of these protocols, creating a new class of financial primitives.
Over the last few months, we have seen increased efforts to tokenize future yield generated from Compound and Aave interest-bearing tokens. We see protocols that give users instant access to future yield by tokenizing and separating the principal and interest portions of future yield. We also see protocols that allow users to take out a loan for “free” and have them paid off automatically over time.
Tokenizing future yield may not seem like much work, but it actually involves incredibly complex mechanisms. In this article, we will be going through some of these innovations and the mechanisms involved. The four projects that we will be going through would be:
APWine, Pendle, and Element have roughly similar mechanisms and they allow users to split an interest-bearing Aave or Compound token into separate principal and yield tokens. With the tokenization of future yield, users can sell these yield tokens to lock in the interest rate received or buy these yield tokens to speculate on yield without committing a large amount of capital.
Alchemix, on the other hand, works slightly differently and allows users to receive yield in advance on deposited assets in the form of debt, which is then slowly paid down using the yield generated from the deposited assets.