@Lorenzo Protocol When designing stBTC, an interesting choice was made: it does not adopt the traditional LST model where a single token represents both principal and earnings. Instead, it separates the principal and earnings into two independent tokens, LPT and YAT. This design may seem like just a technical detail, but it actually reveals a profound understanding of the underlying logic of DeFi.
First, let's talk about how traditional LSTs work, such as Lido's stETH. When you stake 1 ETH, you receive 1 stETH. The value of stETH will grow as staking rewards accumulate, and after some time, 1 stETH might be redeemable for 1.05 ETH. The advantage of this model is its simplicity; users only need to hold one token, with both the principal and earnings included. However, the downside is its lack of flexibility.
If you are an institutional investor, you might only want stable principal exposure without taking on the risk of return volatility. Conversely, you might want to leverage staking returns heavily, but don't want to bear the risk of principal price fluctuations. Under the traditional LST model, these two demands are hard to satisfy.
Lorenzo's stBTC separates these two demands. When you stake BTC, you will receive two tokens: one is LPT representing the principal, and the other is YAT representing future staking rewards. LPT is pegged to BTC at a 1:1 ratio, theoretically with no premiums or discounts. YAT, however, is variable; its value depends on the expected yield from Babylon's staking.
This separation brings many play styles. For example, conservative investors can only hold LPT and sell YAT, which effectively locks in returns in advance. Although the selling price of YAT may be lower than holding it to maturity, it brings certainty. Aggressive investors can buy YAT in the market, using very little principal to bet on high returns. If the APY of Babylon's staking exceeds expectations, the value of YAT will surge.
From a market structure perspective, this separation creates two independent trading markets. The LPT market is mainly dominated by users who need BTC exposure, and the price should stay closely linked to BTC. The YAT market resembles a yield derivative market, where participants are betting on the future yield of Babylon's staking.
This separation is not a new concept in traditional finance. For example, the separation of principal and interest trading in the bond market allows a bond to be split into a principal part and an interest part that can be traded separately. Institutional investors will selectively buy principal or interest based on their liability matching needs. Lorenzo has transferred this logic to BTC staking.
But the DeFi environment is very different from traditional finance. The biggest difference is liquidity. The traditional bond market has market makers and well-established pricing models, allowing for large trades between institutions. DeFi's liquidity is much worse. If the liquidity of stBTC's LPT and YAT markets is insufficient, the benefits of this separation cannot be realized.
From Lorenzo's deployment on Sui, they are indeed working hard to establish liquidity. The collaboration with NAVI allows LPT to be used as collateral for lending, and the cooperation with Cetus provides the LPT/wBTC trading pair. However, the liquidity pool for YAT has not yet been seen, possibly due to the complex pricing of YAT, which market makers are unwilling to bear the risk of.
The pricing of YAT is indeed a technical challenge. Its value depends on several variables: the APY of Babylon's staking, the remaining staking period, Lorenzo's fees, and the market's risk appetite. These variables are all dynamically changing, and giving YAT a reasonable valuation requires complex models. Retail investors find it difficult to judge whether YAT is cheap or expensive.
Lorenzo should provide some auxiliary tools to help users with pricing, such as a yield calculator that inputs the current APY of Babylon and remaining days to automatically calculate the theoretical value of YAT, or providing historical yield curves for users to refer to past data for decision-making.
From a risk management perspective, the separation of principal and yield actually also separates the risks. LPT mainly bears the risk of BTC price and custody risk, which are systemic risks that are hard to avoid. YAT bears the yield risk. If the APY of Babylon's staking is lower than expected, or if there are issues with the Babylon protocol, the value of YAT will drop significantly.
This risk separation has different meanings for different types of users. If you are a BTC whale with hundreds of BTC, you might choose to hold LPT and sell YAT to the market, so your BTC remains BTC, just with added liquidity. If you are a DeFi speculator with a small principal but high risk appetite, you might specifically buy YAT to leverage small funds for large returns.
But this model also has a potential problem, which is the selling pressure of YAT. If most stakers choose to sell YAT, the supply of YAT in the market will be very large, but demand may not keep up, causing the price of YAT to be pushed very low. At this time, buyers of YAT can acquire future rights to returns at a very low price, but this also means that the cash-out price for stakers is very poor.
Lorenzo needs to balance the supply and demand of this market. One way is to provide additional incentives to users holding YAT, such as rewarding long-term holders of YAT with BANK tokens or designing a buyback mechanism where the protocol uses treasury funds to buy back YAT when its price falls below a certain threshold to support the price.
From a technical implementation perspective, the separation of LPT and YAT requires precise tracking of each stake's principal and accumulated yield at the smart contract level. This poses a challenge to the complexity of the contracts. If there are bugs, it could lead to errors in the correspondence of principal and yield, resulting in users receiving incorrect amounts of LPT or YAT.
Lorenzo's contract has been audited by Zellic and CertiK, but has this complex separation logic been adequately tested? Have various extreme scenarios been considered, such as users holding multiple stakes at different times or partially redeeming in between? In these scenarios, will the calculations for LPT and YAT go wrong?
$BANK Holders can adjust the relevant parameters of LPT and YAT through governance, such as whether to allow YAT to trade across staking plans and whether to introduce a buyback mechanism for YAT. These decisions will directly affect the market performance of stBTC and user experience.
#LorenzoProtocol The design of principal and yield separation represents a beneficial attempt at product innovation in DeFi. Although it increases system complexity, it provides more refined choices for users with different risk preferences. If the market acceptance is good, this model may be adopted by other LST projects.
