Decentralized Finance (DeFi) has transformed the interaction process with financial assets, providing access to lending and borrowing, as well as the creation of yields without permission. One of the most important assets in DeFi is composability, also known as financial Lego blocks in which protocols are built upon to enable complex financial services to be constructed with simple interoperable concerns. An example of such is yield bearing tokens, like liquid staked derivatives, which can accumulate value over time, but may still be used as liquidity in pools or as collateral.
In the traditional finance, Exchange-Traded Funds (ETFs) offer a diversified exposure in a single investment to be traded. Applying this to DeFi results in composable yield funds: tokenized funds, which earn revenue as a result of underlying strategies and can be combined with other protocols. These on-chain ETFs should be transparent, automated, and modular in order to succeed in the ecosystem of DeFi. One of the important facilitators is Lorenzo Protocol that ties Bitcoin liquidity to advanced yield tokenization.
Lorenzo Protocol is an institutional-grade on-chain asset management protocol that is intended to be the Liquidity Finance Layer of Bitcoin. Lorenzo was originally dedicated to staking Bitcoin liquidly through Babylon-integration, which enables BTC staking to obtain Proof-of-Stake networks, but now it is a full-fledged infrastructure for true yield. Through Babylon, users post BTC and receive native rewards and receive liquid tokens such as stBTC (staked BTC), a liquid staking token rewarding (LST) and liquid, earning Babylon staking yields and ecosystem points.
The core of the innovation of Lorenzo is defined by the Financial Abstraction Layer (FAL), a modular framework that tokenizes complex yield strategies to standardized and verifiable parts. The FAL separates the custody, lending, trading, and execution into plug-and-play modules meaning that the protocol can bundle both on-chain and off-chain strategies into available products. This is a direct support of the composable yield ETFs via On-Chain Traded Funds (OTFs).
OTFs operate in the form of on-chain analogs of conventional ETFs. Every OTF is a tokenized yield product, e.g. fixed yield stablecoin vaults, delta-neutral trading, or dynamic leverage positions, which can be accessed through a single tradable ticker. The users place their assets (e.g., BTC through enzoBTC, a 1:1 redeemable wrapped token, or stablecoins) in the vaults operated by the protocol. These vaults implement strategies, and can often be an amalgamation of CeFi-grade strategies such as arbitrage or quant trading with DeFi primitives.
OTFs are actually composable due to the standardization. OTF shares are ERC-20-compatible tokens and yield bearing: they do not require claim, and will increase in value or reward shareholders. The following design can be integrated seamlessly throughout DeFi:
Secure in lending procedures.
Provide liquidity on DEXs.
Act as a building block of higher-order products.
Simple Vaults that Lorenzo endorses include: single strategy (e.g.: pure Babylon BTC staking using stBTC) and Composed Vaults (using automated rebalancing to make up a portfolio). The flagship USD1+ product is an example where lending, making stakes in BTC, and other yielding assets are combined into a dollar-pegged product with low volatility. These OTFs can be further developed by developers into custom funds, and this allows recursive innovation.
The cross-chain integrations (through bridges such as Chainlink CCIP and LayerZero) developed by Lorenzo make the problem of composability even more complete. Being deployed on chains such as Ethereum, Arbitrum, BNB Chain, and others, OTF tokens are freely movable, and the user can use them in various ecosystems. This is an important DeFi pain point that is liquidity fragmentation. Lorenzo turns untapped capital (e.g. Bitcoin or stablecoins) into real yield, not inflationary token rewards by loaning it out to validated yield opportunities.
Institutional adoption is all about security. Lorenzo uses a multi-signing custody with such providers as Cobo and Ceffu, audited bridges, and on-chain verification. This institutional-grade solution renders OTFs appropriate to highly advanced users and at the same time, accessible to retail participants.
Essentially, Lorenzo Protocol takes a step forward in composable yield ETFs through opaque yield farming into modular, ETF-like products. OTFs provide composable real yield that unlocks the potential of Bitcoin in DeFi and mediates on-chain conventional strategies. With the maturity of DeFi, maximizing the opportunities of platforms such as Lorenzo may prove to be the re-invention of asset management and thus, yield of the same quality as that of the foundational primitives of DeFi.
