Original Title: The State of Onchain Yield: From Stablecoins to DeFi and Beyond

Original Author: Christopher Rosa

Original Translation: Peggy, BlockBeats

Editor's Note: This report systematically breaks down the five major sources of onchain yield: interest rate transmission of tokenized cash, staking and restaking rewards, lending rate spread, AMM fees, and structured design. Currently, various onchain yield tools are flourishing in the market, from stablecoin wrappers to restaking/LRTs, and structured vaults. Most discussions focus on annualized numbers. The report provides us with a deeper view of what risks lie behind high yields. In fact, APY does not equal actual returns. The key is how much is left after discounting for risk and complexity.

In today's market, there are more and more projects with attractive yields. As the number of yield tools surges, the gap between explosiveness and sustainability is widening. Understanding the balance between yield, risk, and operational complexity is the key to identifying long-term value. Investors should always ask themselves two questions: How much risk have I taken on? After operational costs, how much have I really netted?

The following is the full text:

One of DeFi's most notable innovations is onchain yield, i.e., income generated through blockchain financial activities without relying on traditional intermediaries. Initially, DeFi's yield mainly came from simple mechanisms such as lending and liquidity provision. Today, this ecosystem has evolved into a strategically diverse and structurally complex field covering various types of risks, economic models, and asset categories.

This article proposes a framework to understand and compare various yield generation methods in the DeFi ecosystem. We categorize and analyze from dimensions such as yield volatility, underlying asset types, yield generation mechanisms, and related risks.

First, we focus on stablecoins that do not generate yield.

These assets are pegged to the dollar, do not pay interest, and are designed for stability and quick settlement rather than creating income for holders. When held on a self-custody or non-reward platform, these assets do not generate any yield. Although some platforms advertise rewards for custodial balances, this article does not include them. What we are concerned with is whether the issuer directly or through platform partners pays cash rewards to holders. Starting from a zero-yield point, we will gradually explore various tools and strategies capable of capturing yield, with increasing complexity and risk.

Next, we will discuss Platform-Dependent Yield-Bearing Stablecoins.

These tokens themselves do not pay native interest; only when a revenue-sharing arrangement is reached between the platform and the issuer, will the platform pass on the earnings to users' custody accounts. The earnings only apply to assets held on that platform; if self-custodied or if the platform does not participate in such an arrangement, then the yield remains zero. We classify such assets separately to avoid conflating the issuer's revenue-sharing mechanism with platform promotions or reward programs. By contrast, there also exists a category of decentralized non-yield-bearing stablecoins, where holders need to actively participate in staking protocols such as sDAI to earn yield.

Following that, the article delves into debt-based strategies, where yield begins to be distributed to holders as intended. Some staked stablecoins allocate a portion of the fixed yield to token holders rather than all to the issuer's reserve. Centralized fiat-collateralized wrapped assets hold short-term government securities and automatically pass through fund earnings.

Next, the article analyzes protocol-level yield mechanisms, those generated through on-chain operations rather than the issuer's reserve. This category includes native staking, restaking, and yield farming mechanisms of Proof of Stake (PoS) assets, as well as lending markets. In these markets, interest rates fluctuate with fund utilization rates and credit demand, usually above risk-free return levels.

After protocols, we examine structured and active yield strategies. These strategies are actively operated or designed by teams or protocols, including projects like Pendle V2, Boros, and Euler V2, which achieve yield through combining cash flows, setting durations, or applying leverage.

The final layer is yield driven by market activity itself, including fees earned by automated market makers (AMMs) providing liquidity, incentive programs, and yield farming.

Lastly, the article introduces a stablecoin risk framework and expands the view, examining the entire ecosystem from the perspectives of yield and risk, as well as yield and complexity. We categorize assets from cash-like stability to more engineered yield structures to help readers evaluate the risk and operational costs associated with each additional percentage point of yield.

Non-Yield-Bearing Stablecoin: Centralized Issuance

Stablecoins are a key liquidity medium between exchanges, wallets, and protocols. Non-yield-bearing stablecoins are usually pegged to the dollar, with their settlement function supported by high-quality, liquid reserve assets, such as short-term government bonds, overnight repurchase agreements, cash held by regulated custodians, or government money market funds, among others.

In this article, we classify USDT, FDUSD, and USD1 as non-interest-bearing stablecoins because these issuers do not directly pay native interest to holders. While some platforms may advertise returns on these assets, such rewards come from the platform's own lending or promotional activities and are not directly paid by the issuer, thus falling outside the scope of this article.

As the largest market-cap stablecoin, USDT serves as an anchor in exchange order books and on-chain paths. Its issuer, Tether, has disclosed reserves concentrated in cash equivalents and other short-term assets, with an "overcollateralization" set aside as a capital buffer to support anchoring stability and redemption mechanisms. USDT does not distribute reserve earnings to holders; the returns touted by exchanges stem from the platform's incentive programs, not direct issuer revenue sharing.

FDUSD, issued by First Digital, operates on a fiat-backed model with reserves including government bonds and cash, primarily distributed to large centralized platforms. The token does not pay native interest, and the displayed Annual Percentage Rate (APR) on the platform falls under the platform's incentive category, not within the issuer's revenue-sharing scope as defined in this article.

USD1 is a newer fiat-backed stablecoin with reserves comprising cash equivalents and some government money market funds. Its current growth relies mainly on exchange distribution and issuer or platform point incentive programs. Categorized as a non-interest-bearing stablecoin due to the lack of native interest payments to holders, promotional rewards do not alter this classification.

By leaving the earnings to the issuer, these tokens remain straightforward. The redemption mechanism is designed for face-value settlement (1 token ≈ 1 dollar), allowing assets to be instantly usable across multiple platforms, with the issuer able to control transfer costs while maintaining deep liquidity.

However, for holders, opportunity cost is significant. Taking Tether's government bond holdings as an example, based on the average yield of short-term bonds, its interest income over the past three years has been approximately $12.6 billion. The result is a stable, highly liquid settlement layer designed more for inclusivity and simplicity than for providing returns to holders.

Platform-Dependent Interest-Bearing Stablecoins

USDC and PYUSD are both fiat-backed, U.S. dollar-pegged stablecoins with reserves composed of high-quality liquid assets. USDC's reserves are partly held in reserve banks, with the remainder invested in short-term bonds and repurchase agreements through government money market funds. PYUSD, issued by Paxos Trust Company, is regulated by the New York State Department of Financial Services, with reserves including short-term bonds and cash.

Where Does the Yield Come From?

Neither of these tokens themselves pay native interest. When held on platforms that are self-custodied or do not participate in a rewards program, users do not earn any yield. The issuer of USDC, Circle, has a commercial arrangement with Coinbase to distribute a portion of the reserve yield to Coinbase, which then uses it to reward users in USDC. For PYUSD, PayPal and Venmo may potentially reward users with balances within their apps through a partnership with Paxos.

These reward programs have some autonomy, usually with caps or tiered structures, and apply only to balances held on specific platforms. The "GENIUS Act," signed by President Trump in July 2025, may restrict such indirect interest pass-through, with the specific impact depending on how regulatory agencies craft enforcement guidelines. If regulations become stricter, platforms may shift from cash rewards to points or cashback forms.

Since each platform holds only a small portion of the circulating supply, most of the reserve yield still belongs to the issuer. This also explains why platforms can advertise attractive yield rates while the issuer still maintains significant profits.

Key Points

Small-cap stablecoins vie for market share: USDT and USDC dominate the stablecoin supply, while smaller projects (such as FDUSD, USD1, PYUSD) compete in the remaining market share. Regardless of where held, USDT does not offer any yield; USDC shares a portion of the custodied balance yield only on the Coinbase platform, which represents only a fraction of the total supply. Therefore, most USDT and USDC holders still do not receive any yield, while the issuer retains most of the treasury interest income. Although PYUSD, USD1, and FDUSD as newcomers have garnered some attention, their combined supply still represents only a small part of the non-yield-bearing stablecoin market, with the market landscape still firmly controlled by long-standing incumbents.

Overlooked interest earnings: The zero-yield structure of USDC and USDT means that retail holders miss out on significant potential interest. With short-term treasury yields exceeding 4%, the opportunity cost of stablecoin idle funds has cumulatively reached billions of dollars in just a few years, highlighting the scale of this structural issue.

Funds staying in "cash-only" stablecoins are essentially just on-chain custody changes. This paves the way for the next stage of decentralized assets, such as non-yield-bearing stablecoins like USDS, DAI, USDf, and USDe, which are fully on-chain minted and burned. These tokens continue the widespread availability of USDT and USDC while relying on a transparent collateral asset portfolio or real-time hedging mechanism, rather than centralized treasury assets. Before further exploring their yield-enhanced versions (such as achieving yield through staking packages), understanding how these foundational layers ensure the $1 value without paying interest is a crucial first step.

Non-Interest-Bearing Stablecoin: Decentralized Issuance

Similar to centralized non-interest-bearing stablecoins, decentralized stablecoins also do not pay interest to holders, but their anchoring mechanism is different. These tokens do not rely on traditional assets such as cash or bonds; instead, they achieve a $1 peg through on-chain mechanisms such as over-collateralization, synthetic hedging, and internal surplus mechanisms.

USDe is a "Delta Neutral" synthetic dollar-pegged stablecoin. Whenever the system receives $1 of underlying collateral assets (such as ETH, stETH, or BTC), it opens a corresponding perpetual contract short position on a designated platform to hedge the spot profit against contract losses. The system also maintains a small stablecoin reserve (around 1%, denominated in USDC/USDT) for redemptions and additional margin calls, and holds a small amount of ETH as collateral for ETH-M (an ETH-denominated contract) short positions. This anchoring mechanism relies on continuous hedging operations and liquidity buffers. The original USDe does not pay any interest; only after pledging as sUSDe can one receive funding fees from perpetual contracts and staking rewards if using Liquidity Staking Tokens (LST) as collateral.

USDS and DAI are over-collateralized stablecoins minted through on-chain vaults. Borrowers must deposit assets (such as ETH, stETH, WBTC, or approved on-chain RWA assets) and can mint USDS or DAI up to a limit based on a risk assessment, with typical collateralization ratios ranging from 115% to 175%, depending on the asset type. If the collateral vault falls below a liquidation threshold, the protocol auctions off the collateral assets to repay the debt. Borrowers pay a floating stability fee and incur penalties during liquidation; these proceeds go to the protocol's surplus pool or treasury for system security or token buybacks, rather than being distributed to regular holders. Holding only USDS or DAI does not generate any returns; rewards are only obtained by participating in savings modules (e.g., DAI -> sDAI, USDS -> sUSDS).

USDf is a stablecoin minted based on an on-chain collateral asset portfolio with a required collateralization ratio of at least 116%. Acceptable collateral assets include stablecoins, BTC, ETH, and some mainstream tokens. The protocol does not have a separate reserve fund; the additional 16% of collateral assets serves as redemption buffers and liquidation guarantees. Holding USDf alone does not yield returns; one must stake it in designated savings modules to earn rewards.

Overall, these designs illustrate that decentralization itself does not imply that stablecoins will generate returns; it simply shifts the anchoring mechanism from fiat reserves to on-chain engineering. Whether depositing collateral assets into an over-collateralization vault or deploying a Delta Neutral hedging structure, the generated returns accrue to the protocol rather than end-users. This undistributed revenue also brings a similar incentive mechanism to centralized stablecoins: once the underlying stablecoin gains market acceptance in terms of stability and liquidity, the market rapidly creates "staking derivatives" versions that pass the underlying cash flow to holders.

The next section will explore these yield-bearing derivative versions, which are the first step in transforming originally idle stablecoins into on-chain productive assets.

Key Points

Diverse designs, shared outcomes: Despite their different structures, all four decentralized non-yield-bearing stablecoins have achieved a 1 USD peg. However, the mechanisms employed are significantly different: USDS relies on a high overcollateralization ratio (around 270%); DAI and USDf provide moderate buffers (approximately 150% and ≥116% respectively); USDe achieves stability through Delta hedging plus a 1% reserve maintenance. While they belong to the same category, their risk profiles are not identical.

Differential adoption: Among decentralized non-yield-bearing stablecoins, USDe has emerged as the most promising project, currently leading in market value and deployed on 22 chains, demonstrating the potential of novel collateral designs in reshaping market share. In comparison, DAI and USDS are in the middle, while USDf remains a niche product.

Opportunity cost persists: Despite their differences in structure, most of these tokens still direct the majority of reserves or strategy income to the protocol treasury rather than holders, highlighting a revenue gap of billions of dollars. It is this gap that has led to the "Collateral Packaging" products to be explored in the next section, aiming to redistribute these yields to users.

Issuer policies determine yield distribution: The yield rates of sDAI and sUSDS fluctuate, usually tied to stability fees. However, Sky is actively encouraging users to migrate to sUSDS, offering better parameters and incentives. Therefore, the yield difference between sUSDS and sDAI not only reflects market conditions but also the issuer's strategic choices.

Decentralized stablecoin volume far surpasses that of small-scale centralized stablecoins: The total market value of the top decentralized non-yield-bearing stablecoins is close to 20 billion USD, while the total market value of small-scale centralized stablecoins is only around 4 billion USD, forming a stark contrast.

After establishing the zero-yield benchmark, we will shift our focus to yield-bearing packaged products such as sUSDS, sDAI, sUSDf, and sUSDe. They transform originally static stablecoins into automatically compounding on-chain assets. The disparity between the "zero return" offered by centralized and decentralized non-yield-bearing tokens and the potential income that their reserve assets can generate reveals a significant market efficiency gap. The collateral treasury is a key tool to fill this gap, allowing users to unleash the earning potential of stablecoins without sacrificing liquidity or composability.

Debt-Based Strategies

Stabilized Value Coin (SVC)

A Stabilized Value Coin is the evolution layer of on-chain dollar-backed assets, allowing users to maintain the spendability and widespread usability of the original token while earning on-chain rewards. When a user deposits USDe, DAI, USDS, or USDf into the protocol's treasury, they receive corresponding wrapped tokens (sUSDe, sDAI, sUSDS, or sUSDf). The redemption value of these wrapped tokens automatically increases as protocol revenue flows in. The earnings are not manifested through the minting of new tokens but rather through the continual strengthening of each wrapped token's claim on the underlying stablecoin, keeping the wallet balance stable while the purchasing power continues to grow exponentially in the background.

Although these wrapped tokens share an automatic compounding mechanism, their underlying cash flow sources are distinct:

sDAI and sUSDS derive from Treasury Interest and Stability Fee income of the overcollateralized debt pool;

sUSDf derives from FalconX's fixed-rate credit income from institutional lending platforms;

sUSDe combines perpetual contract funding rates and liquidity mining rewards, collected through Ethena's Delta-neutral hedging strategy.

These mechanisms collectively transform idle stablecoin balances that were in an opportunity cost state into flexible USD-denominated savings tools that can freely circulate within DeFi.

The regulatory treatment of different wrapped tokens varies across jurisdictions. In some markets, such products may be deemed as securities or collective investment tools. Hence, some issuers may implement geofencing for U.S. users or provide access through exemptions for qualified investors.

Wrapped tokens can directly access the lending market, liquidity pools, and leverage loops, allowing users to flexibly switch between "stability" and "yield" based on their needs, converting the same dollar-based asset into an interest-bearing on-chain instrument.

Key Points

Ethena's sUSDe has become a flagship product in the Stabilized Value Coin sector: Within the entire stablecoin collateralization sector, sUSDe currently dominates in Total Value Locked (TVL), daily earnings, and cumulative distribution amount, far exceeding sDAI, sUSDS, and sUSDf.

In early 2024, the sUSDe yield once surpassed 50%. At this stage, Ethena generated exceptionally high income from perpetual contract funding rates and basis trading, while the staking rewards from its ETH collateral also contributed an additional few percentage points. Due to the initial low amount of staked USDe, the limited sUSDe supply led to a concentration of rewards, thereby driving up the Annual Percentage Yield (APY). As funds continued to flow in and arbitrage opportunities narrowed, the same pool had to distribute rewards among a larger base of sUSDe holders, causing the yield to decline.

In the mid-2024 period, the funding rates also stabilized, further compressing the yield. Today, the 30-day rolling APY of sUSDe is stable in the range of approximately 7% to 12%, still reflecting positive fund inflows but no longer in the early high-volatility state.

What Caused the Recent Increase in sUSDe Yield?

The yield of sUSDe comes from the daily accruable funding and incentive income, divided by the current circulating sUSDe quantity. Recently, three developments have increased the numerator while the denominator remained relatively constant:

SPAC Funding Driving ENA Buybacks, Enhanced Basis Trading

In July 2025, the Special Purpose Acquisition Company (SPAC) TLGY, slated for listing, announced its intention to merge with the treasury company stablecoinX within the Ethena ecosystem and accompany this with approximately $360 million in PIPE investments (comprising $260 million in cash and $100 million in ENA). The cash portion was used to buy back locked ENA from an Ethena Foundation subsidiary, with the Foundation subsequently deploying these funds for approximately six weeks of daily $5 million ENA buybacks. This transaction is expected to be completed in the fourth quarter, after which stablecoinX will continue accumulating ENA under a multi-year agreement. Liquidity providers hedge this liquidity with the same spot-long/perpetual-short basis trades as Ethena, thereby boosting the funding rate and increasing sUSDe's income sources.

Treasury Redeemptions Decrease USDe Circulation, But sUSDe Remains Stable

 Ethena's treasury has been repurchasing USDe on the secondary market for redemption, reducing the circulation of non-staked USDe, while the sUSDe supply has remained almost unchanged. As protocol revenues are only distributed to sUSDe holders, with the denominator remaining constant and the numerator rising, each sUSDe's yield has increased. In short: as stakable USDe decreases, the issuance of new sUSDe decreases, avoiding dilution of the yield.

「Leveraged Yield Farming」 Incentives on the Aave Protocol

Under Aave's Efficient Mode (E-Mode), users can leverage a 50% USDe / 50% sUSDe position and, in addition to native sUSDe rewards, receive approximately 12% in platform incentive tokens distributed daily.

Yield Rates Converging: Following the funding rate volatility at the end of 2024, the 30-day rolling annualized yield rates of the four collateral stablecoins have begun to converge. The extreme fluctuations of sUSDe have stabilized, currently centered around 10%, which is comparable to the caps of other products.

Yield Discrepancies Reflect Underlying Mechanism Design: The yield rate adjustments for sDAI and sUSDS are relatively smooth, controlled by governance mechanisms; whereas the yield curves of sUSDe and sUSDf are more volatile, reflecting their reliance on perpetual contract funding rates and institutional credit flows. Overall, the yield ranges of all four stablecoins have stabilized in the mid to low double-digit percentage range.

Centralized Fiat-Collateralized Yield Stablecoins

Centralized fiat-collateralized yield stablecoins are tokenized assets issued based on regulated fiat equivalents (such as USD deposits and short-term treasuries), usually custodied by a single trust entity or asset manager. The issuer operates within a strict regulatory framework, must adhere to KYC (Know Your Customer) and AML (Anti-Money Laundering) processes, often caters only to accredited investors, and regularly releases audit or attestation reports to demonstrate that each token is backed 1:1 by assets.

It sounds similar to USDC and USDT. However, unlike these two mainstream stablecoins, these tokens distribute yield to holders. As long as a user's address is whitelisted and the assets stay within the issuer's ecosystem, the yield is automatically allocated without additional action. The trade-off is also clear: investors benefit from professional custody, transparent audits, and institutional-grade onboarding, but lose the composability, open liquidity, and mint/burn features of a fully decentralized model.

Distinct from the "GENIUS Act"-constrained payment-type stablecoins, tokens like BlackRock's BUIDL and Franklin Templeton's BENJI, which tokenize cash equivalent funds, are classified as securities and can still distribute fund earnings under securities law. Ondo's USDY, also issued as a security, thus has its retail availability in the US limited by securities law, not the GENIUS Act. In summary, the GENIUS Act restricts interest payments on payment-type stablecoins but does not prohibit interest distribution for tokenized money market funds or similar securities.

Key Points

The Tokenized Sovereign Debt Market has seen exponential growth: The market value in April 2025 reached $5.6 billion, an increase of about $4.7 billion compared to the previous period, representing a staggering 545% growth and hitting a historical high.

Debt Trackers "Wearing Token Clothes": These tokens allocate around 80%–100% of their reserve funds to short-term U.S. treasuries and overnight repurchase agreements, so their 4%–5% yield is essentially a pass-through of the front-end treasury yields. The yield is market-determined, reflecting supply and demand dynamics and market expectations of the Fed's policy path. Therefore, the annualized yield of these tokens is highly correlated with the 3-month treasury yield, deviating slightly only due to fees, cash drag, or asset allocation differences.

High Barrier to Entry, Limited Distribution Channels: The primary issuance of BUIDL, BENJI, and USDY is only available to qualified investors, which also explains the small number of on-chain addresses they hold: BENJI has less than 1,000 addresses, while BUIDL has fewer than 100, despite their multi-billion-dollar market caps.

High Market Concentration, Clear Target Users: BUIDL alone accounts for nearly half of the sector's market cap, evidently targeting institutional treasuries looking to gain exposure to the tokenized money markets; USDY and BENJI attract a smaller-scale investor base focused on real-world asset (RWA) collateralization.

Limited Liquidity: Currently listed on only 5–10 trading platforms, with primary liquidity concentrated in permissioned institutional channels rather than public AMM markets. Until these tokens are listed on a wider range of exchanges and enhance on-chain liquidity, they resemble more "tokenized fund shares" than truly interchangeable, composable stablecoins.

So far, stablecoin yields are primarily derived from the debt structure of the traditional financial system, with returns dependent on off-chain collateral and interest rates, ultimately determined by the issuer, banks, and liquidity providers. The operation of protocol-level yields, however, is markedly different: rewards are distributed in native token form, with funding sources including block rewards, transaction fees, and other on-chain revenues. The native re-staking mechanism further utilizes the same collateral asset for multiple services to earn additional returns, shifting risk from traditional finance to smart contracts, slashing mechanisms, and enhanced cross-protocol correlation.

Protocol-Based Yield

Native Staking Mechanism

The native staking mechanism transforms Proof-of-Stake (PoS) tokens into productive assets, allowing holders to share in the income validators receive for securing and operating the network (net of validator commissions). Most of the yield comes from newly minted tokens used to compensate validators for proposing blocks and validating transactions; another portion comes from transaction fees and other on-chain revenue sources, such as Maximal Extractable Value (MEV), which is gradually increasing.

Due to the token inflation rate decreasing over time and fee income being correlated with network activity fluctuations, the actual yield is a dynamic variable affected by the tokenomics of the protocol, network throughput, and validator behavior. When evaluating staking rewards, one must consider both the liquidity cost of staking and tail risks such as slashing.

Where Does the Yield Come From? (Using Ethereum as an Example)

Ethereum is currently the largest staking protocol by volume, and here are its main sources of income:

Newly issued ETH (protocol rewards)

Ethereum issues new ETH through a PoS mechanism.

The rewards are allocated to validators for:

Proposing blocks (when selected as block proposer)

Validating blocks (voting on block validity)

Participating in the beacon chain (used for light client support)

These base rewards adjust algorithmically based on the total staked ETH in the network.

Priority Fees

Users can attach priority fees when submitting transactions to incentivize validators to process transactions more quickly.

Unlike base fees, priority fees are not burned but are directly paid to the validator proposing the block.

Priority fees are volatile, often increasing during network congestion or periods of DeFi activity.

Maximal Extractable Value (MEV)

If validators integrate MEV relays or block producers, they can extract additional value by reordering, inserting, or censoring transactions in a block.

Common MEV strategies include:

Sandwich attacks

Decentralized exchange arbitrage

Front-running of liquidation events

MEV rewards are optional, non-guaranteed, and only available to validators accessing MEV relays (such as Flashbots).

MEV income is highly volatile, significantly influenced by market activity and validator participation.

Native Staking on Ethereum

Self-running validation node (minimum 32 ETH)

Deposit exactly 32 ETH into the official staking contract.

Run a validator node yourself, ensuring the node is online to avoid penalties.

All rewards go directly to the validator's balance.

If you need to withdraw funds, you must initiate the exit process and wait in the validator queue.

Earnings Source: From block proposal, block validation, and priority fees collected through validator participation.

Through Exchange Staking (e.g., Coinbase, Kraken) — Custodial Native Staking

Deposit ETH into your exchange account and select "Stake."

The exchange uses its validator infrastructure to stake the user's ETH.

Users will not receive staking rewards tokens (unless they actively choose wrapped tokens like cbETH).

Rewards will appear in the platform's staking balance.

Exchanges usually take a certain fee from staking rewards.

Earnings Source: Shared between the exchange and users, similar to running a node yourself. Users receive net earnings after deducting platform fees.

Key Points

Earnings Source Structure: Rewards primarily come from two channels: most chains pay validators or delegators with newly issued tokens, while another part comes from transaction fees and on-chain income (e.g., MEV). This structural difference is crucial—newly issued tokens are inflationary, while fee-driven earnings do not dilute token value.

Real Earnings Perspective: Nominal APR must be evaluated in conjunction with token supply expansion and validator commission. A high APR may result in negative actual purchasing power after deducting inflation and fees, while models like Ethereum with a burn mechanism may lead to actual earnings higher than the stated rate.

Relationship Between Participation and Security: A higher staking ratio usually means more economic weight is used to secure the network, but it can also compress the yield and reduce circulating supply, potentially exacerbating price volatility when large holders exit.

Liquidity Differences: There are significant differences in unstaking times across different chains: for example, Hedera's HBAR or Cardano's ADA can be withdrawn instantly, while Stellar's XLM and Polkadot's DOT require waiting for several weeks, with the timeframe not being fixed. Ethereum's experience shows that even in a "flexible" system, congestion can occur when many validators exit simultaneously.

Risk

Exit Queue Congestion: In late July 2025, the scale of Ethereum validator exits from the queue surpassed 600,000 ETH, equivalent to around $2.3 billion, with a wait time extending to over 8 days, setting a new historical record. Galaxy's report "Why Ethereum's Exit Queue Suddenly Expanded" provides a detailed analysis of this. Such a backlog during market pressure periods may result in trapped funds and form price pressure when staked tokens eventually flow into exchanges.

Punishment Mechanism and Performance Risk: Validators may face slashing or downtime penalties for double-signing or offline behavior, leading to a loss of part of their staked assets. Delegators also bear this tail risk, therefore they must trust the operational capability and discipline of the supported node.

Reward Volatility: The token's monetary policy may change (e.g., XLM recently reduced its maximum inflation rate to 10%), and fee income fluctuates with network usage, therefore there is no guarantee of consistent stable earnings.

Smart Contract and Cross-Chain Bridge Risk: Even with native staking, validator software and underlying protocols rely on complex smart contracts and code, which may contain vulnerabilities or security risks. Although native staking avoids the bridge and oracle risks common in liquid staking, it still exposes potential issues in client implementation or consensus rules.

Regulatory and Tax Uncertainty: Different jurisdictions have varying tax timing (upon receipt or upon sale) for staking rewards, and policy changes can quickly alter the economic benefits of staking.

Re-Staking

As mentioned earlier, since Ethereum transitioned from Proof of Work (PoW) to Proof of Stake (PoS) in 2022, staking has become one of the foundational practices in DeFi. By locking ETH (or SOL on Solana) in a network contract, token holders help maintain consensus security and receive rewards. Traditional staking, while supporting the network's validation mechanism, also means that assets are locked up until the exit or unbonding process is completed, restricting liquidity and keeping capital idle that could otherwise be used for other purposes.

Liquid Staking addresses this limitation. When staking ETH or SOL, users receive a tradable representation of their staked assets in the form of a Liquid Staking Token (LST). After receiving LST, holders can trade, lend, or use it as collateral in DeFi while still earning the base staking rewards.

In essence, liquid staking delegates native staking to a third-party operator in exchange for a composable token.

Where Does the Yield Come From?

The yield from liquid staking comes from the same source as native staking. The difference lies in the operation: users delegate the validator's operational responsibilities (key management, node online rate, block proposal and validation, fee and MEV settings) to a third-party operator and receive a liquid staking token (LST) that can be freely used in DeFi. The following sections will further explore the application opportunities of these tokens in the on-chain ecosystem.

Risks and Considerations

Unpegging Risk

Liquid staking tokens (LST) such as stETH are designed to maintain a peg to ETH, but this peg may deviate. In a recent example, stETH experienced a discount due to a triple pressure scenario: a surge in ETH borrowing costs on the Aave protocol, user leverage accumulation in recursive staking, and validator queue congestion leading to delayed redemptions. In this scenario, arbitrage mechanisms weaken, the pool becomes unbalanced, and the LST price may deviate from ETH. If large holders concentrate sell-offs in times of illiquidity, even a slight imbalance may persist unless the market has deeper, more stable liquidity or faster redemption mechanisms.

Liquidity Crisis

The ability of users to enter and exit LST positions smoothly heavily depends on the health of the secondary market. For example, the Curve Finance stETH/ETH trading pair serves as a major liquidity hub for stETH but is prone to imbalance during market volatility. If a large amount of LST is dumped into these pools, it may lead to one-sided liquidity, resulting in high slippage and poor trade execution. Despite Lido's staked amount exceeding 9 million ETH, its market share has recently declined, coupled with Curve pool parameter adjustments, exposing vulnerabilities in the LST liquidity infrastructure. Once liquidity thins out and the queue for exits piles up, users may be left holding discounted assets and unable to redeem immediately.

Leverage Amplification Effect

Many users borrow ETH by using LST (such as stETH or rETH) as collateral, then exchange ETH for more LST and re-stake, creating a leverage loop. This strategy can amplify returns in a stable market but also introduces systemic risk. When the peg deviates or interest rates surge, such positions are prone to liquidation, potentially triggering a cascade of LST sell-offs, further depressing prices, draining liquidity pools, and triggering more liquidations, forming a feedback loop. Leverage amplifies returns but also exacerbates risks, especially in volatile markets.

Centralization and Counterparty Risk

While the LST protocol aims to decentralize the staking process, many still rely on a few validator operators and governance structures. For example, Lido manages a significant amount of liquid staked ETH, introducing systemic centralization risk. Any governance issues, validator mistakes, or smart contract vulnerabilities could impact protocol stability and trigger a market chain reaction. Furthermore, the DeFi ecosystem's reliance on a few liquidity pools and wrapped tokens makes design parameters (such as Curve's amplification factor or redemption mechanism) have a significant impact on user experience and market health.

Redemption Delay and Market Vulnerability

Although Ethereum has supported staked ETH withdrawal since the 2023 Shapella upgrade, LST's redemption process still relies on the blockchain's validator exit queue. During peak demand periods, this queue could become heavily congested, leading to redemption delays. If the secondary market is also under pressure at this time, users may not be able to sell redeemed ETH at face value. The mismatch between redemption logic and market liquidity exposes LST to liquidity shortage risks during times of high volatility or structural pressure.

Liquidity Re-Staking

Liquidity re-staking is the next stage of on-chain capital efficiency, built on top of liquid staking. Through protocols like EigenLayer, users can deposit their liquid staking tokens (LST) into an "Active Validation Service" (AVS) – decentralized systems that require trustless validators for security assurances. In exchange, users receive a new form of liquid re-staking token (LRT), such as eETH, ezETH, or rsETH. These LRTs retain the composability and liquidity of the original LST while adding new sources of yield.

The core advantage of liquidity re-staking lies in its incentive stacking capabilities:

Users continue to receive native staking rewards from Ethereum;

They can also receive incentives provided by the AVS, including points (similar to a crypto version of "air miles"), airdrops, and early token distribution;

Many LRT protocols also support DeFi integrations such as liquidity mining, borrowing, etc., further enhancing potential returns without sacrificing asset liquidity.

This multi-layered incentive structure transforms what was once a passive, locked-up collateral asset into an income-generating, active tool for participating in DeFi. It turns ETH or SOL into multi-purpose capital that can simultaneously secure multiple networks and earn rewards from them.

As the staking economy matures, Liquid Staking is poised to become a key part of Ethereum and Solana's modular infrastructure.

Where Does the Yield Come From?

Liquid Staking Tokens (LRT) unlock additional yield sources on top of standard staking rewards to enhance overall returns. This includes the following aspects:

Validator Service Incentives: LRT participation in services like EigenLayer's "Active Validation Service" (AVS) secures emerging decentralized services and rewards stakers with incentives such as points (similar to a crypto version of frequent flyer miles), early token distribution, or future airdrops.

Protocol Incentive Programs: Issuers of LRT (e.g., Renzo, ether.fi, Kelp DAO) typically introduce loyalty points, reward multipliers, or liquidity mining activities to attract user participation. These incentives can significantly boost net rewards, especially in the early stages.

DeFi Integration: LRT can usually be deposited into lending markets, decentralized exchange (DEX) liquidity pools, or automated treasuries, allowing users to earn additional on-chain rewards while receiving staking rewards.

Key Points

LRT extends staking to a new yield layer

Liquid Staking Tokens (LRT) re-deploy already staked ETH or SOL into decentralized services to secure them, unlocking new incentive sources beyond standard staking rewards.

Staking rewards are AVS-driven, not just Ethereum

Unlike LST, which relies solely on Ethereum's native PoS rewards, LRT adds incentives from AVS, including points, airdrops, and early token distribution, representing an expanded revenue path for EigenLayer and its ecosystem.

LRT maintains liquidity and composability

Similar to LST, LRT is an ERC-20 (or SPL on Solana) token that can be freely traded, participate in DeFi, and access lending markets, treasuries, and AMMs. Users can earn rewards continuously without locking up their assets.

Not all rewards are paid in ETH or SOL

Currently, many LRT rewards come in the form of points, future protocol tokens, or ecosystem incentives. These rewards are not always liquid or predictable, but they play a central role in the current yield strategy.

Protocols foster competition through multi-layered incentives

Leading LRT issuers (such as Renzo, ether.fi, Kelp DAO) actively boost user returns through loyalty points, reward multiplier mechanisms, and integration with EigenLayer and collaborating AVS, making LRT a dynamic component of DeFi yield stacking.

LRT is still in a developmental stage

Re-staking remains a nascent area, with ongoing attention required around slashing penalties, AVS reliability, smart contract complexity, and incentive dilution risks.

Risk

The composability of LRT brings powerful strategies but also intertwines risks. If a particular AVS is attacked or node operators breach slashing rules, multiple positions may simultaneously face penalties, leading to shared losses for LRT holders, LST holders, and native stakers. The seemingly attractive yield stacking relies heavily on operator prudence, governance transparency, and the market's resilience to liquidity shocks, particularly during significant position concentration exits.

Lending Mechanism

On-chain lending transforms idle tokens into productive capital. Depositors provide assets to a money market contract and receive interest-bearing tokens; borrowers, in an overcollateralized manner, borrow assets from the liquidity pool at a floating interest rate. Interest rates increase as the fund utilization rate rises. When a position's collateral falls below a safe threshold, the smart contract automatically triggers a liquidation mechanism. Interest paid by borrowers flows in real-time to depositors, so the yield reflects the market's instant demand for leverage.

Unlike non-yield-bearing stablecoins held statically in wallets as digital cash, DeFi lending protocols bring these assets into a shared liquidity pool, making them productive capital. Anyone can deposit stablecoins, instantly becoming a "lender" and earning a floating rate set by the protocol's algorithm. Borrowers, on the other hand, must provide separate collateral assets, borrow funds from the public pool, and repay interest back to the pool. This mechanism builds a real-time functioning credit market where the supply-demand relationship continuously adjusts: when borrowing demand surges, yields rise; when liquidity is abundant, yields fall. The liquidation process automatically executes when the collateral asset value falls below the safety threshold.

Essentially, a non-yield-bearing stablecoin only provides a USD exposure to a single issuer and does not generate income; whereas the DeFi lending market recycles these collateral assets among multiple participants, transforming idle tokens into a systemic credit tool, while distributing income and risk between lenders and borrowers.

Where Does the Yield Come From?

Lending protocols work together through various mechanisms to create overlapping yield paths for both sides of the market.

Interest Paid by Borrowers

At its core, lenders receive variable interest income paid by borrowers. The interest rate adjusts dynamically based on the utilization rate—higher borrowing demand leads to higher interest rates. Borrowers may use the funds for risk hedging, leverage, or releasing liquidity without selling assets.

Protocol Incentive Programs

Many lending protocols, especially in the early or growth stages, distribute native governance tokens (such as COMP, AAVE, MORPHO) to lenders and borrowers. These incentives act as subsidies, boosting the lenders' net annualized return rate (APY) while offsetting the borrowers' costs. In some cases, the incentive distribution may even exceed the base interest rate, enabling "yield farming" even in a low-interest environment.

Native Asset Yield

When users lend out assets with native yield (such as stETH, rETH, or ezETH), they can still receive the staking or re-staking rewards embedded in these tokens. These rewards passively accumulate while the assets are deployed in the lending pool, forming a dual source of income:

Part comes from the staking or re-staking mechanism;

Part comes from lending interest or protocol incentives.

In some cases, this structure can be further amplified through leverage cycles (such as lending out ETH and then re-staking or lending again), achieving compound returns.

Yield Stack Mechanism: Key Innovation in DeFi

Yield stacking is gradually becoming a representative innovative mechanism in the DeFi space. Previous analyses have indicated that users can stake ETH or SOL for Liquidity Staking Tokens (LSTs), such as stETH, rETH, or JitoSOL, and further re-stake them for Liquidity Re-Staking Tokens (LRTs), such as eETH or ezETH. These underlying assets themselves can earn ongoing rewards through the protocol staking and re-staking process.

However, this is only the initial level of the yield structure.

On lending platforms such as Aave, users can deposit LST or LRT into the lending market to earn additional interest on top of their existing staking rewards. These platforms typically pay depositors a floating Annual Percentage Yield (APY) with funds sourced from borrowers providing collateral assets for liquidity. This mechanism enables users to have a dual yield approach without the need to unstake or sell their assets: one from protocol staking and the other from interest income in the lending market.

The emergence of this model reflects that DeFi yield strategies are evolving towards a more complex and efficient direction.

Achieving Yield Layering with stETH

Let's say a user holds $10,000 worth of stETH, which represents ETH staked through Lido and continuously earns Ethereum's native staking rewards. Instead of passively holding stETH in a wallet, this user chooses to deposit it into Aave V3—the protocol's most advanced market—as collateral.

Through this action, the user not only continues to receive staking rewards from stETH but also qualifies for additional lending income from the Aave protocol. On Aave's platform, other users can borrow stETH, and the holder of stETH can earn a share of the interest paid by the borrowers.

This strategy allows a single asset to generate multiple income sources simultaneously by combining passive staking rewards with protocol-level lending returns while maintaining the liquidity of the collateral asset to access funds when needed.

Stablecoin Yield Layering Strategy

The concept of yield layering naturally extends to stablecoins. For instance, a user can deposit stETH into Aave as collateral and borrow stablecoins such as USDe or DAI.

The borrowed stablecoins can further be utilized for:

Re-depositing into Aave or other protocols to earn lending returns

Entering yield farms or automated strategy vaults

Swapping for more stETH or other LST to cycle holdings and increase exposure

Whether through passive holding or active deployment, this portion of borrowed funds forms a second layer of a broader yield strategy, making leverage a composable, capital-efficient tool to maximize returns across multiple protocols.

Yield Farming Loop Mechanism on Aave

Aave also enables users to achieve yield stacking through a "loop" operation, where after borrowing funds against collateral, users reinvest the borrowed asset back into the same asset type. For example, a user can use stETH as collateral, borrow ETH, convert the ETH to more stETH, and then deposit it back into Aave. Each loop increases the user's exposure to stETH, further compounding their staking and borrowing yields. This strategy is commonly referred to as "leveraged staking."

While loop operations can amplify potential returns, they also introduce leverage risk. Since this strategy relies on debt support, changes in market conditions (such as stETH price falling below ETH or an increase in borrowing rates) can quickly elevate the loan-to-value ratio (LTV). Once the LTV exceeds the protocol's set liquidation threshold, the user's collateral may face partial or full liquidation.

Therefore, loop strategies are inherently more volatile, especially in environments with lower liquidity or significant market fluctuations and require active monitoring. For most users, this is a high-reward strategy that demands risk tolerance and operational precision.

The stack of colored bands in the chart above shows capital scattering across dozens of chain-specific deployments. While this diversifies tail risk, it also dilutes on-chain liquidity and forces traders to bridge or pay up for cross-chain liquidity, an operational headache that did not exist when lending was an almost pure Ethereum story in 2020-2021.

Together, the charts confirm that the lending sector has recovered in size but not in efficiency: abundant deposits chase episodic borrowing booms, rates gyrate accordingly, and liquidity is now spread over far more venues and chains than in the last cycle, a landscape that rewards active rate-shopping and careful collateral management.

Key Points

Market activity is returning to high levels, but the structure is undergoing change. The DeFi lending market is nearing historic activity highs, but there has been a noticeable shift in fund structure. Currently, the total supply in the money markets has exceeded 800 billion USD, with outstanding loans approaching 350 billion USD, returning to levels seen during the 2021–2022 bull market. The Ethereum mainnet (depicted in black in the chart) remains a key support, but the fastest-growing segments are coming from Layer 2 networks like Optimism and emerging alternative Layer 1 networks, aligning with the migration trend highlighted in Galaxy Research's "Crypto Lending Landscape Report" released in April.

Despite the overall uptick in activity, fund utilization rates remain subdued, reflecting structural liquidity excess. In each market upcycle, the gap between fund supply and lending continues to widen, with only around 40% of deposits actually lent out. This "idle" state has kept mainstream asset lending rates at moderate levels, even as market speculative demand rises without significant fluctuations.

Lending costs exhibit cyclical fluctuations rather than a long-term trend. The stablecoin annual percentage rate (APR) on the Ethereum mainnet was below 2% by the end of 2022, but during the first quarter of 2024's funding rate turbulence, it surged to 15% at one point. The current 7-day moving average remains stable in the 5%–6% range. This pattern aligns with observations in the April report, indicating that lending yields are closely tied to leverage trading activities (such as arbitrage and rehypothecation loops) rather than stemming from sustainable credit demand.

Risk Factors in DeFi Lending

Liquidity Mismatch and Utilization Risk

The current deposit size in the DeFi lending market is nearing 850 billion USD, while outstanding loans are only around 350 billion USD, meaning approximately 60% of funds are idle. As noted in Galaxy's April lending report: "By the end of 2024, the total open DeFi borrowing volume was only $19 billion, covering 20 protocols, despite rebounding nearly 9.6x from the bear market low." If the market suddenly shifts towards safer yield avenues, protocols may be forced to lower interest rates or incentivize fund withdrawals, particularly putting pressure on smaller chains with weaker liquidity.

Collateral Asset Diversification and Liquidation Centralization

Currently, over a dozen L1 and L2 networks host lending pools, but the liquidation mechanism for most assets still relies on a few bots and arbitrage executors. Once a price cascading impact occurs, cross-chain liquidation may happen rapidly, potentially surpassing the response capacity of bridging or arbitrage mechanisms, amplifying market retractions during each funding rate spike.

Interest Rate Volatility Driven by Speculative Leverage, Not Sustainable Credit Demand

Since 2021, the stablecoin Annual Percentage Rate (APR) in the Ethereum lending market has experienced intense fluctuations ranging from 2% to 16%. This fluctuation is primarily influenced by funding rate trades and the rehypothecation loop rather than genuine funding demand. A report by Galaxy pointed out: "Lending returns are closely tied to leveraged trading rather than long-term credit demand." Investors need to be aware that high-yield moments (such as rates exceeding 12%) are often short-lived and quickly revert to the mean.

Asymmetric Access

While anyone can provide liquidity, many high-yield opportunities (such as a standalone lending pool on a small L2) often require cross-chain operations, custom oracles, or governance whitelist permissions. Regular users who leave their funds on the mainnet may face similar market risks but receive lower returns, reflecting a structural issue of "risk-return mismatch," which is not reflected in surface-level APR metrics.

In summary, despite the continuous growth in scale of the DeFi lending market, it still faces structural risks such as liquidity mismatch and cyclical fluctuations. These risks are not common in collateralized stablecoins that do not generate yield, such as the CDP model. Investors, while seeking returns, need to carefully evaluate the systemic vulnerabilities behind them.

Structured Yield

As DeFi gradually transitions from basic lending and staking mechanisms to more complex financial structures, a new wave of protocols is exploring how to repackage and customize yields themselves. This field is known as "Structured Yield," which aims to make the yield mechanism closer to complex instruments in traditional finance by separating, automating, or tokenizing future cash flows.

Among them, Pendle and Euler v2 are innovative projects that are representative in this field. Both strive to provide users with more advanced yield strategies, but take different paths: Pendle achieves yield splitting and trading through yield tokenization, while Euler v2 builds a flexible yield portfolio through modular strategy vaults.

Pendle V2

Maximum Boosted Annual Percentage Yield (Max Boosted APY): The "Maximum Boosted Annual Percentage Yield" displayed by Pendle is a theoretical limit, assuming the user receives the full vePENDLE incentive bonus, selects the optimal liquidity pool, continuously captures rewards, and follows the current incentive plan. This yield is subject to volatility, dependent on the incentive mechanism, and does not constitute a guarantee. It usually requires locking the PENDLE token or actively managing LP (Liquidity Provider) and YT (Yield Token) positions. Actual yields may be significantly lower than the theoretical value and do not include transaction fees, slippage, and gas costs.

Pendle is a DeFi protocol that allows users to split interest-bearing assets into two separate tokens, enabling a more granular control of yield over time. This mechanism is known as Yield Tokenization, allowing users to separate, trade, and structure yield, breaking free from the constraints of traditional staking or lending protocols.

When a user deposits a supported asset (such as stETH, ezETH, sDAI, or USDe), Pendle locks the asset and issues:

Principal Token (PT): Represents the right to redeem the original asset at a set maturity date. PT does not generate yield and usually trades at a discount. Holding PT is equivalent to locking in a fixed return, regardless of how the market yield fluctuates during the holding period.

Yield Token (YT): Captures all the floating yield generated from the investment start to the maturity period. YT holders receive returns based on the accumulated yield, and its market price reflects the expectations of future rewards, making it suitable for speculation or hedging against interest rate movements.

This structure is similar to the "Principal/Interest Separation" mechanism introduced on Wall Street in the 1980s with mortgage-backed securities, allowing users to customize exposure according to their risk appetite. Risk-averse users can purchase PT to lock in a fixed yield, while those seeking high returns or directional trades can purchase YT to access variable returns like staking APY or protocol incentives. These tokens can be freely traded, either in combination or individually.

Users can use PT tokens as collateral to deposit into Aave or Morpho and manually engage in yield farming strategies. However, such strategies require active management, including monitoring borrowing limits, liquidation risks, and position rebalancing during market fluctuations. Lending platforms usually accept PT rather than YT, as PT is akin to zero-coupon bonds that mature at face value, making pricing and risk assessment more straightforward. YT, on the other hand, is a floating yield token that decays over time and is typically not accepted as collateral.

Pendle separates principal from yield and automates operations through its ecosystem tools. For example, the Boros protocol builds PT yield farming strategies based on Pendle: using PT as collateral for borrowing, purchasing more PT, redepositing, and repeating the operation within a predefined risk range. The goal is to capture the interest rate differential between the implied fixed return of PT and the floating borrowing rate, net of fees and slippage, to generate a stable yield. While yield farming strategies are common in DeFi, this "fixed spread" model is unique to Pendle PT design. Cycling operations on other assets (such as LST) are mainly used to leverage exposure rather than lock in a spread.

Boros

Boros is a platform within the Pendle ecosystem that focuses on automating the execution of a specific type of yield strategy — principal token (PT) leveraged yield farming based on interest rate spreads. Unlike manual interaction with Pendle by users, Boros encapsulates the entire process into a simplified vault mechanism, allowing users to earn amplified fixed income without having to personally manage the complex flow.

At a high level, Boros' vault executes the following cyclic operation:

Buy discounted principal tokens (such as PT-USDe or PT-sDAI) on Pendle, which can be redeemed at face value upon maturity;

Deposit the held PT as collateral into lending platforms like Morpho or Aave;

Borrow stablecoins (such as USDC or USDe) against the PT collateral;

Use the borrowed stablecoins to buy more PT;

Repeat the above process, continuously compounding the exposure.

This cycle leverages capital efficiency to amplify the returns on Pendle's fixed income position, effectively building a leveraged exposure to fixed income assets. The core of this strategy lies in the positive spread between the implied fixed income rate of PT and the floating borrowing rate on the lending platforms. As long as the borrowing cost is lower than the implied yield of PT, the strategy can achieve a net positive return.

Boros automates the above cycle through smart contract vaults, managing collateral ratios, borrowing limits, and position health, freeing users from manual surveillance of liquidation risks or rebalancing. Vault parameters are preset and publicly auditable, allowing users to choose different risk levels and maturity structures based on their preferences.

By simplifying complex multi-step operations into one-time deposits, Boros transforms advanced rate arbitrage strategies into deployable DeFi tools, enabling users to capture structured yield in a more capital-efficient manner within the Pendle ecosystem.

Where Does the Yield Come From?

In the Pendle protocol, stETH is split into two types of tokens:

YT-stETH (Yield Token): Currently trading at around 0.04 stETH

PT-stETH (Principal Token): Currently trading at around 0.96 stETH

Expiration Time: Approximately one year

Base Annualized Yield (Lido Staking): Approximately 5%

Market Implied Annualized Yield of PT: Approximately 4.2%

When a user purchases 1 YT-stETH, they receive full staking rewards entitlement for that stETH until expiration. If the staking reward over the year is 0.05 stETH and the user only paid 0.04 stETH to purchase YT, the net profit is 0.01 stETH, resulting in a 25% annualized return, without the need for leverage or borrowing.

Yield Token (YT)
YT grants the holder the right to all the underlying asset's earnings, in this case, the staking rewards on Lido's stETH. Yield is the actual staking rewards received minus the cost of purchasing YT. Due to YT's trading price being significantly below face value, even modest yields can result in high capital returns. Therefore, YT is often seen as a "quasi-leveraged" yield instrument, without involving borrowing or liquidation risks. If actual returns exceed the market-implied yield, YT holders will receive excess returns.

Principal Token (PT)
PT represents the principal portion. Users purchase PT at a discount (e.g., 0.96 stETH) and redeem at 1 stETH face value upon expiration. This discount is the fixed return. PT behaves like a zero-coupon bond, with the price gradually converging to face value as the expiration approaches. The "fixed annualized yield" displayed in the Pendle application is the yield at expiration. PT does not participate in staking rewards or incentive points, offering stable and predictable returns.

Trading Flexibility
In Pendle's Automated Market Maker (AMM), PT and YT can be freely traded before expiration:

YT: Can be sold at any time, with a common strategy being to sell early when the yield is realized or when market rates increase and prices surge to lock in profits.

PT: Can also be sold at any time. While holding until expiration provides the full discounted return, selling when PT prices increase due to falling market rates or increased demand for fixed yields is also possible.

Boros Yield Mechanism

Boros executes an automated loop strategy based on Pendle's Principal Token (PT), leveraging the spread between PT's fixed return and stablecoin borrowing costs to generate structured returns.

The specific process is as follows:

Fixed Income Source: Boros Treasury first purchases Pendle's principal tokens (such as PT-USDe or PT-sDAI), which usually trade at a discount and can be redeemed at face value upon maturity.

Leverage Strategy: Boros uses PT as collateral to borrow stablecoins (such as USDC or USDe) on platforms like Morpho or Aave, then uses the borrowed funds to buy more PT, increasing the position size. This cycle can be repeated multiple times within the risk threshold to amplify the returns on the original capital.

Spread Income: The core income of this strategy comes from the spread between the PT fixed interest rate and the variable interest rate on the lending platform. The net income is approximately the PT annualized yield minus the borrowing rate and related fees and slippage. The Treasury operates in a loop within the risk limit, with the final income being the net spread multiplied by the leverage factor. A larger spread leads to higher returns; if the borrowing rate is higher than the PT yield, the strategy may result in negative returns.

Cycling Efficiency: Refers to the exposure scale that can be achieved per unit of capital after accounting for slippage, fees, and collateralization ratio limits. The higher the efficiency, the more cycles can be executed, and the higher the leverage factor; the lower the efficiency, the more limited the amplification effect.

Optional Incentive Layer: Some treasuries may layer Pendle's incentive mechanisms (such as PENDLE distribution or LP rewards) to further boost returns. Although these incentives are not guaranteed, they can significantly enhance the net APY under specific market conditions.

Through automated cycling and smart contract management, Boros transforms complex fixed income arbitrage strategies into a one-click DeFi Treasury, allowing users to obtain structured, leveraged returns in a more capital-efficient manner under on-chain logic guarantee.

Risks and Considerations

Yield Token (YT) Risk
If the market price of the Yield Token (YT) implies an annualized yield higher than the actual yield of the underlying collateral asset, the transaction may fail to achieve the expected return unless market conditions improve. Even if the implied yield at the initial purchase is lower than the actual yield, the future staking APY may still decline to below the expected level at the time of purchase.

Time Effect on YT Price
As the Pendle token approaches maturity, the price of YT usually gradually declines because its value is reduced to the remaining unpaid accrued yield, unless there is a significant change in the underlying asset's yield.

Interest Rate and Market Value Fluctuations (PT)
The market price of the Principal Token (PT) fluctuates with interest rate expectations. Selling before maturity may result in actual returns higher or lower than the originally expected fixed income; holding until maturity allows for redemption at face value.

Settlement-Free ≠ Risk-Free
The "quasi-leveraging" feature of YT stems from its pricing mechanism, rather than borrowing behavior, thus eliminating the risk of liquidation or oracle manipulation. However, the ultimate return still depends on whether future revenues materialize.

Pendle Yield Curve: Inverted Structure

The yield of short-term expiry tokens is higher than that of long-term tokens. This phenomenon is typically driven by the following factors:

PTs nearing expiry usually trade at a deeper discount

Market demand is concentrated on short-term trades

Investors may be pricing in uncertainty or volatility in the long-term market

Traditional Sovereign Bond Yield Curve: Normal Structure

Long-term bonds generally offer a higher yield to compensate for time and inflation risks. This is a common structure in traditional interest rate markets (such as U.S. Treasuries).

Yields in traditional finance reference the U.S. Treasury Department's fixed-term series (such as 1-month, 3-month, 6-month T-bills, and 1-year, 2-year, 5-year Treasury bonds).

Euler V2

The Euler V2 protocol, through its decentralized lending market, offers users a foundational yield opportunity. Users can deposit assets into standalone vaults compliant with the ERC-4626 standard to earn interest or use them as collateral to borrow other tokens with customizable rates. However, the platform's core innovation lies in its "Managed Strategy Vaults." These vaults are typically managed by risk curators who dynamically adjust parameters for optimal risk management, automatically execute complex DeFi operations, enabling users to deploy funds into structured products with minimal manual intervention.

By tokenizing strategy tokens into transferable shares, Euler V2 transforms passive lending into actively managed positions, enhancing the composability of the entire ecosystem.

Strategy One: Leveraged Circular Operations on LST and LRT

What Is This?

This strategy is a recursive borrowing mechanism aimed at amplifying exposure to yield-generating tokens. Users deposit LST (Liquidity Staking Token) or LRT (Liquidity Re-Staking Token) into the vault. The vault then uses this asset as collateral to borrow the underlying asset (usually WETH), exchanges the borrowed WETH for more original LST/LRT, and re-deposits it into the vault. This process, known as "cycling" or "folding," leverages through repeated operations, magnifying the user's base yield.

Involved Assets

The primary assets include high-quality LST (such as wstETH) and LRT (such as eETH), with the lent-out asset typically being WETH.

Earning Source

This strategy's earnings come from two channels: the staking or restaking annual percentage yield (APY) of LST/LRT itself, and the supply APY that the Euler Treasury pays on the deposited assets. Due to position leverage, both staking/restaking rewards and supply rewards accumulate based on a larger nominal amount, thereby enhancing the overall return.

Strategy Two: Leveraged LP (Liquidity Provider) Position

What Is This

This strategy allows Liquidity Providers (LPs) to earn from holding LP tokens while leveraging these tokens. Users deposit LP tokens from an automated market maker (such as Uniswap) into the Euler Treasury. The Treasury uses these tokens as collateral to borrow one of the base assets in that trading pair. The borrowed asset can be used to purchase more LP tokens or free up funds for other purposes, all without selling the original LP tokens.

Involved Assets

The collateral asset is the LP token (such as WETH/USDC LP), and the borrowed asset is the underlying asset in that trading pair (such as WETH or USDC).

Earning Source

The primary earnings come from the underlying returns of the LP position, namely the trading fees generated in the AMM pool. Through leverage, users can amplify their exposure to these fees. Additionally, users also receive the supply annual percentage yield (APY) that the Euler platform pays for providing LP token collateral.

Strategy Three: Delta-Neutral Farming Strategy

What Is This

This is an advanced strategy designed to generate income while minimizing asset price volatility risk. Users deposit stablecoins (such as USDC) as collateral in the Treasury, which then borrows volatile assets (such as ETH) and immediately exchanges them for more stablecoins. This creates a "Delta-Neutral" position, where the user's earnings come from the interest rate differential rather than the price movement of the volatile asset.

Involved Assets

Stablecoins (USDC, DAI) as collateral, volatile assets (ETH, WBTC) as borrowed assets.

Earning Source

The earnings are entirely derived from the net interest rate spread. Users receive supply earnings from staking stablecoins as collateral, while paying the borrowing cost of volatile assets. As long as the stablecoin earnings exceed the borrowing cost, the strategy yields a positive return.

Strategy Four: Cross-Protocol Yield Arbitrage

What Is This

This is an opportunistic strategy that leverages interest rate differentials between different DeFi protocols for arbitrage. Euler's treasury can be programmed to borrow assets on Euler at a relatively low rate and then deposit those assets into other protocols (such as Pendle, Yearn, or emerging incentive-based money markets) to earn a higher annualized yield. This is an on-chain "carry trade" strategy.

Involved Assets

The assets typically used for arbitrage are stablecoins or WETH, as they have deep liquidity in the DeFi ecosystem.

Earning Source

The earnings directly come from the interest rate differential between two protocols. It is the APY obtained on an external protocol minus the borrowing cost on Euler. Such earnings are highly volatile and depend on short-term market imbalances and incentive mechanisms.

Risk Disclosure and Key Points

Euler v2's Architecture Improvements and Risk Considerations

While Euler v2 introduces a modular lending architecture and key risk management mechanisms, there are still a series of risk factors affecting asset suppliers and borrowers:

Euler v1 Hack Incident

In March 2023, Euler Finance v1 was subject to an attack where approximately $190 million worth of crypto assets (including DAI, wBTC, stETH, and USDC) were stolen. The attacker exploited a flash loan operation to manipulate the liquidation process through functions not thoroughly checked in the protocol, ultimately siphoning assets out of the reserves. Although most of the funds were recovered in subsequent investigations and negotiations, this incident exposed vulnerabilities in collateral integrity, liquidation logic, and flash loan attacks, reminding us that even audited protocols may still have complex logic flaws, especially when leveraging mechanisms and automated financial actions.

Interest Rate Fluctuation Risk

Euler employs an Interest Rate Model (IRM) based on utilization, where the supply APY fluctuates with borrowing demand. When utilization is low, earnings may approach zero, and when utilization is high, while returns might increase, it may also reflect liquidity constraints. Interest rate changes can occur rapidly, especially in treasuries using dynamic IRMs.

Liquidity Constraint

Users can only withdraw assets when there is idle liquidity in the vault. In high utilization scenarios, it may not be possible to exit a position immediately, and one may have to wait for borrower repayments or new funds to come in. This risk is particularly prominent in assets with high market volatility or a narrow borrower base.

Underlying Asset Price Risk

When users provide assets to the vault, they are exposed to the price risk of that asset. If a token de-pegs, undergoes an attack, or performs poorly due to strategy failure, its value will decrease. Some vaults use yield-bearing assets (such as sDAI or wstETH), which can offer additional returns but also introduce protocol-specific risks.

Reward Sustainability Risk

Some markets exhibit high APYs due to external incentives (on-chain reward flows or point distributions from platforms like Merkle). These incentives are temporary and uncertain, and once they end, the actual yield may drop significantly, catching users who entered based on high yield expectations off guard.

Vault Governance Risk

Each vault is managed by a specific governance entity that can adjust reserve factors, interest rate curves, caps, and collateral parameters. These changes will affect interest calculations and the vault's risk profile. Asset suppliers need to trust the governance entity's rational and transparent decision-making, but this is not an absolute guarantee.

Smart Contract Risk

Euler v2 has been re-architected and audited after the v1 exploit event, but it is still a complex system containing custom interest rate models, governance controls, and token integrations. Vulnerabilities in the core contract or interest rate calculation logic could still lead to fund losses or risk misjudgment. While smart contract risks can be mitigated, they cannot be completely eliminated.

Oracle and Pricing Dependency

Euler relies on external oracles (such as Chainlink or Pyth) for collateral and borrowing asset pricing. If an oracle fails, experiences delays, or is manipulated, it can result in incorrect interest rate adjustments, asset price distortions, or even trigger a systemic vault shutdown. Despite widespread validation of oracle infrastructure, it remains a critical dependency.

Protocol Governance and Systemic Risk

The Euler protocol is governed by Euler DAO, which can authorize upgrades, pause mechanisms, or adjust vault policies. If DAO operations stagnate or are manipulated, it will affect the protocol's responsiveness and security mechanisms. Additionally, Euler v2 inherits systemic risks from the Ethereum ecosystem.

Activity-Generated Yield

Liquidity Provider

A Liquidity Provider (LP) refers to a user who proportionally deposits two tokens into a decentralized exchange (DEX)'s liquidity pool to provide trading pairs for traders. In return, users receive a portion of the transaction fees collected by that liquidity pool. Unlike lending, LPing does not involve borrowers; their assets are held in an Automated Market Maker (AMM) contract, where the contract is responsible for pricing and executing the trades. For example, providing liquidity in the wETH/USDC pool on Uniswap v3 requires users to deposit wETH and USDC in equal value proportions.

Understanding How LPing Works

What is an AMM?

In traditional exchanges or order book systems, users place orders that are matched by counterparties. These counterparties are typically market makers who provide quotes, take inventory risks, and profit from the bid-ask spread and exchange rebates. Prices are determined by the active quoting and matching of buy and sell orders, and trades only execute when someone is willing to accept your price.

However, in an AMM, counterparties are pools of tokens managed by smart contracts. The contract calculates prices based on the token balances in the pool using a formula and always provides quotes. Users trade with the liquidity pool rather than a specific institutional counterparty. Anyone can deposit tokens into the pool and proportionally share the fees paid by traders. The pool's price adjusts with balance changes, and arbitrage mechanisms help keep the price in line with external markets.

A simple analogy: An order book is a "marketplace" of buyers and sellers, while an AMM is an asset pair's "vending machine." The vending machine prices based on the remaining items on the shelf, and transaction fees are distributed to the "restocking" liquidity providers.

Why Are There Different Trading Pairs and Pools?

If an AMM is like an asset vending machine, then what is "on the shelf" is crucial. AMMs are organized by trading pairs, with each pair consisting of two assets, such as wETH/USDC or USDC/USDT. Trading pairs exist to facilitate direct exchanges between specific assets.

Highly correlated assets (such as stablecoins) are suited for low slippage formulas and low fees, while assets with higher volatility require more flexible pricing mechanisms, often accompanied by higher fees. Within the same trading pair, there may be multiple pools with different fee rates, allowing traders and LPs to choose the most suitable economic model based on market conditions.

Uniswap v3's Pools and Fee Tiers

Each trading pair in Uniswap v3 has multiple pools, each corresponding to a different fee tier. For example, the wETH/USDC trading pair is most active in the 0.05% and 0.30% fee pools. Liquidity is not shared between pools of different fee tiers, so LP returns depend on the chosen fee tier and price range.

How to Choose a Fee Tier and Its Trade-offs

0.05% Pool: Suitable for markets with low volatility and small spreads. This pool usually has higher trading volume, especially when gas costs are lower on Layer 2 networks, allowing LPs to earn a significant amount of small fees. The downside is that each transaction pays less in fees, relying on sustained trading volume to cover inventory risk and management costs.

0.30% Pool: Suitable for markets with higher volatility or larger spreads, or when the 0.05% pool is too crowded and LP share is small. Each transaction pays a higher fee, helping to offset inventory risk. However, trading volume is usually lower, fee income is more volatile, and there is a stronger path dependency.

Price Range and Tick Mechanism

Uniswap v3 divides prices into small units called Ticks. After selecting a trading pair and fee tier, LPs need to set the price range where their liquidity will be active. The upper and lower limits must align with multiples of the Tick, and LPs only earn fees when the market price is within that range.

As trades move the price within the Tick range, LP assets swap between the two tokens, and fees are allocated to LPs in the current Tick range.

Narrow Range: High fee density when in range, but requires frequent monitoring as you may miss out on returns if the price deviates.

Wide Range: Lower fee per unit of liquidity, but stays in range longer, reducing maintenance costs.

Out of Range: LP assets will be concentrated in one token and will not earn fees unless the range is readjusted or the market price returns.

Providing Liquidity to AMM Pools and Fee Tier Selection

Once you have selected a trading pair, the pool's fee tier, and the price range where your liquidity will be active, you need to deposit an equivalent amount of the two tokens. The smart contract will mint an LP non-fungible token (NFT) that records your share and earned fees.

As long as the market price fluctuates within the range you set, you will continue to receive fee rewards. The liquidity pool will automatically adjust your position between wETH and USDC. If the price goes beyond your set range, you will stop earning fees until you readjust your range or the market price returns to your Tick range. You can exit at any time by removing liquidity and claiming any outstanding fees.

Operation Summary:

Choose Pool and Fee Tier: In Uniswap v3, the wETH/USDC trading pair is most active at fee tiers of 0.05% and 0.30%. The high fee pool pays more per transaction but may have lower volume, while the low fee pool generally has higher volume.

Set Price Range: For example, when the ETH price is $3,200, you can set a range of $2,800 to $3,600. A narrower range can provide higher returns within its effective range but is more likely to fail, while a wider range has lower return density but stays active longer.

Deposit Equivalent Tokens to the Range: The contract will mint an NFT representing your position.

Earn Fees by Trading within the Range: Fees accumulate in the contract until you claim them.

Price Out of Range: You will mostly hold one of the assets and no longer earn fees until:

A) You burn the NFT, claim the fees, and reset the range;

B) The market price returns to your Tick range.

Exit Anytime: Remove liquidity to withdraw your tokens and unclaimed fees.

Impermanent Loss

In LP operations, there is a key concept to understand called Impermanent Loss (IL). We will continue to use providing wETH/USDC liquidity on Uniswap v3 as an example to explain its mechanism and its impact on earnings.

Impermanent Loss refers to the difference between the value of your LP holdings and the value if you had simply held the original tokens without participating in LP. The received fees can partially or entirely offset this difference.

How does the liquidity pool automatically rebalance your position?

In a 50/50 pool like wETH/USDC, the AMM will maintain the price through trading behavior. When wETH increases, the contract sells some wETH for USDC; when wETH decreases, it buys wETH with USDC. In Uniswap v3, this mechanism only works when the market price is within your set Tick range; if the price goes beyond the range, you will stop earning fees and mostly hold one asset until you adjust the range or the price returns.

When is Impermanent Loss Realized?

It is called "impermanent" because it is only a floating loss on paper; if the price returns to the level when you entered the LP, the loss will disappear. You only truly realize IL when you close or adjust your position, such as burning LP tokens to exit or burning and redeploying to adjust the price range. Claiming fees itself does not realize IL; your actual position only becomes the pool's current token composition when you exit or rebalance, thus realizing gains/losses.

LP Investment Choices

Concentrated Liquidity AMMs (such as Uniswap v3)

These types of liquidity provision mechanisms allow users to select a price range to provide liquidity within. A narrower price range can achieve higher fee density when the price is within the range, but it requires more frequent monitoring and rebalancing. A wider range earns less fee per unit of capital but has a longer active time and lower maintenance costs.

Stablecoin Exchange-type AMMs (such as Curve's stablecoin pools)

These pools focus on assets with prices close to a peg (e.g., USDC/USDT) and typically offer more stable fee income with lower impermanent loss. Their returns are mainly driven by trading volume rather than price fluctuations.

Weighted and Multi-Asset Pools (such as Balancer)

These pools are more akin to portfolio exposure. Fee income will gain or lose based on trading volumes and incentive mechanisms in asset allocation.

On-chain Trading Venues on High Throughput Chains (such as BNB Chain or Solana)

These platforms may have lower fees per transaction but high volumes. Their economic model still depends on several core factors: whether the price is in an efficient range, the proportion of active liquidity, market volatility, and incentive mechanisms.

Where Does the Yield Come From?

Transaction Fees (Swap Fees)

Every trade that crosses your set Tick range pays a fee to the pool, and you only earn a proportion of that fee when the market price is within your set price range. In summary, your fee earnings depend on several factors:

The chosen fee level

The volume of trades near your range

Your Share of Active Liquidity in the Range

If liquidity providers are too concentrated in a certain range, your share will be diluted; while setting a narrower price range can increase the fee density per unit of capital, it also makes the position more vulnerable to impermanent loss due to price divergence, increasing price risk. Additionally, gas costs and the operational cost of redeploying liquidity can erode actual returns, especially on the Ethereum mainnet.

It is important to note that many platforms display annualized returns (APY) based on short-term backtesting, which may exhibit volatility; meanwhile, trading volume may shift between different pools or chains. Transaction fees indeed are a significant source of LP returns, but they are inherently volatile and path-dependent. The final return depends on whether the trading flow passes through your range and how much of that flow you capture.

Incentive Mechanisms and Why Many LPs Chase Them

Some platforms provide additional token rewards to attract liquidity. These incentive mechanisms can significantly boost the advertised annualized return (APR), attracting more capital inflow. However, these incentives are often temporary and may change at any time due to governance votes or budget adjustments. Once the incentives decrease or end, the APY can quickly decline. If fee income itself is low and a position seems profitable only due to incentives, it may turn into a loss once the incentives are gone.

Incentive mechanisms can enhance LP returns for a period of time, but they are not a sustainable income source. Therefore, it is advised to always assess the base APY first, consider incentives as a short-term bonus, and be prepared for their sudden disappearance.

LP returns are not a fixed number. The actual LP return is the result of multiple factors, including:

Fee capture within the effective liquidity range

Inventory changes due to price fluctuations (i.e., impermanent loss)

Management strategies and costs (e.g., redeployment frequency, gas expenses, hedging, etc.)

Any minor change in these variables can turn a position that was once profitable into a loss.

Is LPing Really Profitable?

Why is it Hard to Measure?

The actual return of an LP = Fee Income − Inventory Drift − Management Costs, and these factors fluctuate with changing market conditions. The same LP position may appear profitable in the short term but could turn into a loss in the long term, and vice versa. This depends on:

How many trades cross your Tick range

The time you spend within the valid range

The trend and volatility of the price during your position

In stablecoin pairs, fee income is typically more stable, and impermanent loss is lower. When trading volume is sufficient and the pool is not congested, the outcome tends to be slightly positive. However, once gas costs, rebalancing frequency, and the new liquidity dilution effect are taken into account, net returns may be compressed.

In blue-chip volatility pairs (such as wETH/USDC), if the market is active and the price fluctuates around the range, it may perform well in the short term. However, over time or in the presence of market trend changes, unhedged inventory skew often devours fee income, resulting in an overall loss unless actively managed or hedged.

Conditions that increase the probability of profit include:

The base fee rate remains attractive even without incentives

The price range set can cover most market activities

The operational environment has low gas costs

Ability to respond promptly to changes in trading volume and volatility

Factors that decrease the probability of profit include:

The pool is too congested

High gas costs

The range is set too narrow and not adjusted in time

The market price runs unilaterally for a long period

Conclusion

LPing can be profitable, but it is not a "passive income tool." The outcome depends on: whether trades cross your range, your time in the range, price paths, and operational costs. Minor variations in these variables or different profit calculation methods can turn a positive result negative.

Additional Risk

Toxic Order Flow

When the real market price changes on an external platform, fast traders or bots will preemptively trade in your pool, completing operations before price updates. They buy from you immediately after a price increase and sell to you immediately after a price decrease, causing you to "buy high, sell low." Although fees can partially mitigate losses, in pools with high volatility or low liquidity, a few informed traders may dominate the market, and fees are often insufficient to cover costs. If the pool sees a lot of daily, non-informative trades, this risk is relatively small, and LPs can earn fees without taking on the worst counterparty risk.

Liquidity Pool and Fee Tier Selection

Some trading pairs have stable daily trading volume, while others have low volume and high volatility. If the fee tier does not match the pair's volatility or typical trade size, it can result in low fee revenue or almost no trading volume.

Price Path and Market Conditions

The LP's performance depends not only on the starting and ending prices of the position but also on the market trends during the position. If the market is stable and prices fluctuate within a range, it usually benefits the LP. However, if the market shows a one-sided trend, the liquidity pool will continue to rebalance in the direction of the trend, potentially causing LP losses.

Tight Range Near Spot Price

An extremely narrow price range behaves like a limit order. When the price quickly moves through your range, the collected fees are often insufficient to cover the losses, especially when considering slippage and non-optimal entry prices.

Instant Liquidity and MEV (Maximal Extractable Value)

Attempting to provide liquidity only when large trades occur is not easy. Faster bots and MEV operations (profiting through reordering or inserting trades) may front-run, resulting in worse execution prices for you and higher gas costs.

Hedging and Revenue Structure Risk

Opening an LP position is essentially like selling insurance against large price swings. Hedging operations themselves incur costs, may lag in fast markets, and can still lead to significant losses in volatile conditions.

Performance Measurement and Benchmark Risk

The LP's performance may reverse depending on the evaluation method. For example, profit in terms of USD may mask the actual loss of the deposited tokens. On-chain data may not reflect off-chain hedging or other background information. Therefore, revenue assessment needs to be cautious to avoid misjudgment.

Yield Farming and Incentivized Liquidity Pool

Yield Farming refers to staking the LP tokens you receive for providing liquidity into a reward contract to earn additional tokens. Incentivized liquidity pools are those that attract liquidity by offering additional rewards.

Example: Participating in CRV Yield Farming on Curve with DAI

Deposit DAI into Curve's DAI liquidity pool to earn transaction fees.

Obtain the LP token for this liquidity pool.

Stake the LP token into Curve's reward pool to continue earning fees and receive CRV incentives.

Claim CRV at any time and decide how to proceed: sell, hold, stake for boosting, or deploy to other protocols (such as lending platforms).

Where Do the Earnings Come From?

Transaction Fees: Each transaction incurs a fee. As long as your liquidity is actively participating in the pool, you will receive a proportional share of this revenue.

CRV Distribution: The pool's incentive mechanism distributes CRV to the staked LP tokens. The reward amount depends on the pool's weight, distribution rate, and your boosting status.

Optional Boosts and Locking Mechanism: Locking CRV as veCRV can enhance rewards. By staking through Convex, you can earn boosted CRV and potentially additional rewards in CVX or partner protocols.

Net Earnings Depend on Cost and Risk: The surface-level APY does not account for impermanent loss, time out of range, gas costs, or price fluctuations of reward tokens. Incentive distributions and Total Value Locked (TVL) of the pool fluctuate over time, affecting actual returns.

You can also participate through an optimizer like Convex. Convex will stake LP tokens on your behalf, pass on CRV and other token rewards, apply boosts to increase your incentive share, and automatically compound at set intervals. If gas costs are reasonable and platform fees are moderate, this method can enhance net returns.

Conservative Earnings Estimate Explanation

Explanation: The following Annual Percentage Yield (APY) data is based on the past 30 days of transaction fees and incentive distributions. It excludes impermanent loss, time out of range, gas costs, or rebalancing fees, thus not providing a complete profit-loss assessment. These APYs are rolling snapshots and fluctuate with changes in trading volume, liquidity, and incentive programs. We separate base fee APY and incentive APY where possible and indicate the snapshot date.

For Curve LP tokens wrapped through Convex, in different types of pools, the conservative baseline APY ranges from 2% to 10%, depending on the incentive mechanism and market conditions.

Stablecoin Pool (via Convex)

Fee revenue alone is typically in the low single digits; if CRV and CVX incentives are active, the conservative range is 2%–6% APY:

FRAX/sDAI: January 2025 APY is 3%, with a base yield of 0.7% and an incentive yield of 2.3%

PYUSD/crvUSD: July 2025 APY is approximately 10.2%, mainly driven by incentives

Blue Chip Hybrid Asset Pool (via Convex)

Higher revenue volatility, relying on incentive programs, with a conservative range of 4%-10% APY:

Convex TriCryptoFRAX: Previous snapshots show a 30-day APY of 5.8%, with incentives being the main driver

LST or ETH Pairs (via Convex)

In times of market stability, APY is usually 2%-4%, with fees and incentives each accounting for half:

stETH/frxETH: APY on August 8, 2025, ranges from 2.6% to 3.4%, with base and incentive yields split evenly

Governance Tokens and Curve Ecosystem Pairs

If incentives are heavily concentrated, returns may be slightly higher, but risk preference also increases accordingly:

CRV/cvxCRV: May 2025 APY is 9.8%, primarily composed of incentives

Risk

Even in stablecoin pools, there are anchoring and smart contract risks. The incentive mechanism may adjust due to governance changes, for example, the CRV issuance rate may decrease, causing your Annual Percentage Rate (APR) to decline.

If you choose a volatile asset pair instead of a stablecoin pool, impermanent loss risk is introduced. During periods of significant price fluctuations, this loss may exceed the fees and incentive rewards you receive, turning your overall strategy into a loss.

Insights

TVL by Category

DeFi has evolved from its initial decentralized exchanges (DEX) and yield farming to an on-chain economy of "yield stacking." The chart above shows that TVL is diversifying from a single structure to a more heterogeneous one: liquidity staking has become a primary source of on-chain capital, the lending market fluctuates with market cycles, and DEXs, as infrastructure, remain stable. Meanwhile, emerging areas such as re-staking, LRT (Liquidity Re-Staking Tokens), and RWA (Real-World Assets) are also rapidly growing from a smaller base.

Unlike the incentive-driven TVL surge seen between 2020 and 2022, today's TVL is more diversified and sustainable, with growth primarily coming from protocol-native revenue support.

The growth of DeFi is not driven by a single narrative but is the result of multiple engines operating simultaneously. With the evolving interest rate environment and L2 adoption, TVL rotates among different sectors—from asset-backed RWA driven by base rates, to protocol security collateralization, to transaction volume-driven DEX and lending markets—each asset class has its unique mechanics and risk characteristics.

The Crossroads of Yield: Banks and Blockchain

After examining the complete on-chain yield pathway, we should also consider its spillover effects on traditional markets, banks, money markets, and other off-chain yield tools.

On-chain stablecoins and yield-bearing cash-like assets are increasingly intertwined with traditional money markets: stablecoin reserves are being allocated to treasuries and repurchase agreements, while tokenized cash competes with bank deposits and retail money market funds for the same pool of short-term USD funds. If this "parallel money market" continues to expand, funds may migrate, reshaping the short-term financing structure, collateral flow paths, and interest rate transmission mechanisms. In many emerging economies, these assets may even become everyday savings and payment instruments, siphoning deposits from local banks and affecting exchange rates.

GENIUS Act: Regulatory Boundaries of On-Chain Yield

The rise of on-chain yield has raised a fundamental question: will it impact the yields of traditional bank savings accounts?

The U.S. "GENIUS Act," signed into effect by President Trump in July, aims to maintain the "currency attributes" of payment-type stablecoins, preventing them from evolving into savings products. The Act stipulates that regulated stablecoin issuers may not pay any form of yield or interest to holders, preventing them from being seen as substitutes for bank deposits.

However, the partnership model between USDC issuers Circle and Coinbase cleverly circumvents this restriction. Circle does not directly pay yield to USDC holders but allocates a portion of reserve yield to Coinbase, which then distributes USDC rewards to users. Economically, users receive yield; legally, the payer is Coinbase, not the issuer. Since both parties openly define this model as "revenue sharing," it does not violate the provision that issuers may not pay interest.

The question remains: will other issuers also emulate this approach to find ways to bypass the GENIUS Act?

The Bank Policy Institute (BPI) opposes this, arguing that indirectly paying interest to users through partners goes against the legislative intent. The organization urges Congress and regulatory agencies to close this "indirect interest payment" loophole and prohibit the issuance of interest through affiliates or agents.

Currently, U.S. policy tends to prohibit stablecoin issuers from paying interest to prevent them from being confused with bank deposits. However, the revenue-sharing mechanism remains a practical channel for on-chain earnings to flow to retail users. Whether this will continue in the future will depend on how the final rules define "interest payments" and whether intermediary institutions are considered part of the issuer.

In an assessment in April, the U.S. Treasury Department pointed out that allowing stablecoins to pay interest could potentially draw up to $6.6 trillion in bank deposits, depending on the scope of the yield coverage. This prediction suggests that on-chain earnings pose a real funding risk to banks: massive capital outflows would undermine banks' low-cost deposit base, forcing them to rely on more expensive wholesale funding channels, ultimately tightening credit and raising borrowing costs for households and businesses.

However, for users, the logic is the opposite: if on-chain products can convey government bond yields or DeFi rewards, they will become a strong alternative to traditional bank savings accounts.

Policymakers are weighing the pros and cons: while interest-bearing stablecoins may drain bank deposits and alter the money market structure, they may also increase demand for government bonds and become a new channel for global capital allocation.

Rising Demand for Stablecoins in High Inflation Countries

As decentralized finance (DeFi) continues to mature, interest-bearing stablecoins and tokenized cash accounts are providing depositors with reasons to move funds from the traditional financial system to the "programmable dollar." In regions where banking services are limited or unstable, capital flows to more practical channels: on-chain assets offer 24/7 settlement capabilities and the prospect of returns, making it a practical choice for daily fund management.

In many parts of the world, inflation has become a daily reality. In countries where annual inflation rates reach double digits or even exceed 25%, households are transferring their domestic currency assets to dollar-pegged stablecoins as a real hedge against currency devaluation. Through mobile wallets and peer-to-peer payment networks, users can transfer funds around the clock, bypass capital controls, and hold an accounting unit that behaves similarly to the dollar without relying on a bank account.

In high-inflation environments, stablecoins are gradually evolving into a "working currency"—widely used for savings, invoicing, cross-border remittances, and international trade. Their advantage lies in combining a familiar dollar-based system with near-instant settlement capabilities globally, providing users with a financially stable and liquid alternative.

This fund transfer is not without risks. Users still face issuer or custodian risks, the possibility of account freezes, and difficulties in cashing out when the on/off-ramps are restricted. However, the attraction remains strong: predictable purchasing power and disposability, far better than the rapid devaluation of local currency.

With the expansion of on-chain payment infrastructure and ongoing optimization of compliance-friendly wallets, the adoption of stablecoins is expected to continue rising in the most fragile monetary systems. For many, stablecoins are not a speculative tool but a survival tool.

The chart above shows the breakdown of USDT market cap by holder type:

Service Addresses: Typically wallets of exchanges or other merchant/FinTech companies, identified by on-chain analytics firm Chainalysis.

Holder Addresses: On average, holding over 2/3 of received USDT.

Sender Addresses: On average, holding less than 2/3, usually used for quick transfers or payments.

In the tracked networks (including Ethereum, TRON, BSC, Solana, Avalanche, TON, Polygon, Arbitrum, Celo, Optimism, Kaia), the holder-held USDT market cap has surpassed that of service and sender addresses, indicating that stablecoins are transitioning from short-term payment tools to long-term value storage tools. This trend aligns with users in high-inflation countries using stablecoins as a hedge against currency depreciation.

If the holder share continues to rise, funds may migrate from bank deposits and offshore retail money market funds to on-chain cash tools, forcing banks and funds to increase competitiveness in terms of interest rates and liquidity.

Once scaled, stablecoin reserves and tokenized cash accounts may directly purchase government bonds and repurchase agreements, diverting demand from the traditional money markets, leading to fragmentation of the global currency market and silently altering the transmission mechanism of policy rates in cross-border markets.

Key Points

Market Overview

The current on-chain yield primarily comes from two broad scenarios:

Off-chain cash tools: Such as high-yield savings accounts, money market funds, and government bonds, these tools earn income through policy rate transmission and have broad distribution channels and deep liquidity. They form the "base rate" of on-chain yield, providing a reference anchor for on-chain products.

On-chain Financial Tools: Building on this foundation, protocol mechanisms and market microstructure are overlaid, including: yield-generating or collateralized stablecoins, lending pools, funding rates and basis trading strategies, AMM transaction fees, protocol staking and restaking mechanisms, as well as structured products that package these cash flows or apply leverage.

As more market behavior or cross-protocol combinations are introduced in the design, the volatility of returns and related risks also increase. Evolving from a "cash+" strategy to "event-driven" and "structured" strategies implies a higher potential for returns, but also comes with higher risks, monitoring requirements, and operational complexity.

Stablecoin Risk Assessment Framework

Stablecoins exhibit significant differences in asset backing, governance structure, and redemption mechanisms, where superficial similarities may mask completely different tail risks.

The framework below scores stablecoins across multiple dimensions, covering risks that may lead to value loss or asset inaccessibility, and consolidates these dimensions into a concise total score for easy comparison. These scores are not ratings or investment advice, but rather information summaries to help readers identify which risks are most prominent in a specific use case and calculate risk-adjusted returns accordingly.

(For a more detailed DeFi risk assessment methodology, we recommend reading A Risk Rating Framework for DeFi and Crypto Investors written by Thaddeus Pinakiewicz of Galaxy Research.)

Stablecoin Risk Categories

Reserve/Collateral Quality: Refers to the quality, liquidity, and transparency of collateral assets, as well as whether there is genuine overcollateralization or redundant reserves.

Anchor Stability Mechanism: Measures the likelihood of the token deviating from a $1 face value on a historical and structural level.

Oracle Risk: Refers to the reliance on external price data and the risk of oracle failures leading to collateral mispricing.

Auditability/Centralization Level: Whether the issuer or contract administrator has the ability to freeze, blacklist, or suspend specific transfers. Regulated issuers typically need to retain such powers for compliance purposes, but this also means holders face the risk of unilateral asset freezes or transaction scrutiny.

Redemption Mechanism: Refers to the convenience, speed, and related conditions of token holders exchanging their tokens for US dollars (or underlying assets), including factors such as the presence of identity verification thresholds, minimum redemption amounts, fees, or lock-up periods that may affect timely exits.

Liquidity Risk: Under market pressure, the probability of forced selling or on-chain liquidation triggering a cascading effect.

Counterparty Risk: The stability and fragility of the token entry and exit channels (such as trading platforms or payment channels) that users rely on.

Regulatory Risk: Involves the clarity, strictness, and jurisdiction of the legal framework in which issuance and reserves operate.

Smart Contract Risk: Includes technical security of the contract code, audit status, upgrade control mechanisms, and the setting of pause or blacklist functionalities.

Governance Mechanism: Involves the centralization of decision-making power and accountability mechanisms for upgrades, parameter adjustments, reserve management, and emergency operations, including key management, voting thresholds, and transparency.

Risk-Adjusted Return

Risk-adjusted return measures the relationship between a token's yield and the risk investors take to achieve that yield. Here, for each stablecoin, we first take its 30-day Annual Percentage Yield (APY), then divide it by the corresponding total risk score in the matrix mentioned above, and finally convert the result into basis points (bps) of return per risk point.

For example, if a stablecoin's result is 18 bps, it means that for each risk point it takes in the matrix, it can generate a 0.18 percentage point annualized return.

A higher value indicates a more efficient "return per unit of risk," while a lower value indicates that investors have not been compensated with a matching return for taking on greater risk.

The chart compares the nominal Annual Percentage Yield (APY) with the risk-adjusted return, which discounts assets with higher risk.

In centralized cash-like stablecoins such as USDC and BUIDL, the risk-adjusted return mostly ranges from 2% to 2.5%, reflecting a moderate risk level based on stable reserve income. PYUSD also falls within this range.

Decentralized yield-bearing stablecoins show greater differences. sUSDf remains at around 3.4% after risk adjustment, as its initial APY reached double digits; sUSDe and sUSDS are adjusted to around 2%; while sDAI, due to its low original APY, is adjusted to only about 0.7%. Tokenized yield products such as BENJI and USDY have risk-adjusted returns slightly below 2%.

The conclusion is: Higher nominal APYs often do not withstand risk adjustments. In this snapshot, only sUSDf stands significantly higher than centralized cash-like stablecoins after risk adjustment.

Earnings vs Risk, Earnings vs Complexity

There are two complementary perspectives to place these tools on the efficiency spectrum:

· Earnings vs Risk: Measuring if taking risk leads to proportional returns;

· Earnings vs Complexity: Examining how much of the earnings can be retained after accounting for operational complexity.

This helps differentiate between the "economics of returns" and the "complexity of realizing returns," allowing readers to see which design can deliver returns under the risk taken and how much of these returns are left after considering operational complexity.

Earnings, Risk, and Complexity Scores

The following chart places various earnings designs on three simple scales ranging from 1 (low) to 5 (high).

The focus is not on exact values but on comparison. By observing the height differences of the bars in the bar chart, you can quickly see which tools can offer higher returns below the risk level and which tools require more maintenance and operation in day-to-day operations.

These scores are based on current design choices and recent market performance and may be adjusted in the future due to changes in liquidity, incentive mechanisms, or protocol parameters.

Return Adjusted for Risk and Complexity

The next chart converts earnings into two efficiency metrics.

Black bars: Represent the return per unit of measured risk.

Orange bars: Further deduct the reduction in efficiency brought about by operational complexity.

The gap between the two bars shows how much of the original efficiency is retained after considering custody, operational processes, and daily monitoring. These scores are comparative snapshots based on design features and recent market performance, rather than exact values.

Insights

The efficiency perspective reveals a clear pattern. Cash-like instruments score highest on "unit risk return" and retain most of their efficiency even after accounting for complexity reductions. Cash-like tokens and similar fixed-income tools (such as Pendle PT) also retain most of the efficiency. Native staking falls in the middle; however, yield farming and LRTs see a larger decrease in returns after adding complexity considerations because they rely on validators, incentive mechanisms, and integration relationships. Structured and incentive-driven designs perform strongly on risk-adjusted returns but relatively poorly after considering complexity; lending markets are roughly at a moderate level. Active AMM LPs have the lowest efficiency and experience the largest drop in efficiency after complexity reduction, consistent with the features of path dependency and inventory effects.

Conclusion

This article explores the five main sources of on-chain yield: policy rate transmission in tokenized cash; protocol rewards for staking and re-staking; credit spread and basis yield in lending pools; market microstructure fees generated by Automated Market Makers (AMMs); and the packaging and leveraging of these yield streams through structured products.

When different designs are layered, their yield engines, volatility, and potential failure points all change.

We compare these tools along three dimensions:

Yield characteristics: including yield level, stability, and reliance on incentives;

Risk composition: covering asset backing and redemption, technology and oracle reliance, liquidity and exit, governance and review risks, as well as leverage factors;

Operational complexity: including custody, cross-application and cross-chain operations, monitoring and reporting, and more.

Off-chain cash tools serve as a benchmark as they anchor many on-chain designs to reference off-chain interest rates.

Measurement and context are equally important. Rolling realized yields may differ significantly from nominal snapshots. Activity-based designs rely on entry timing, price paths, and market cycles for outcomes. Incentive-driven components are often transient; efficiency improves when more yield can be retained long-term without incentives.

Interdependencies are part of the product. Many designs layer chains, cross-chain bridges, oracles, money markets, and staking layers. Since the same components (such as a particular layer 2 network, cross-chain bridge, oracle, or LST) are often reused across different products and protocols, if one link fails, it may simultaneously impact multiple positions, introducing correlation risk.

The importance of liquidity and exit is equal to returns: market depth, redemption terms, queuing, and restrictions will determine position performance during market contraction.

On-chain yield is not magic. It is essentially: the packaging of policy rates, the distribution of protocol rewards, the pricing of credit, and the redistribution of fees. Labels may change, but the engine remains the same. Interpreting any yield figure requires a dual perspective: how much you earned for the risk and how much is left after considering all operating costs.

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