Oct 14, 2025
Generating yield in crypto markets remains a complex challenge for both retail and professional investors alike. Higher yields often come with elevated credit, liquidity, smart contract or other risk exposure.
Liquid Yield Tokens (LYTs) address these complexities by aggregating yield from investment-grade Real-World Assets (RWAs) and DeFi protocols into a single, liquid ERC20 token.
This article explores how yield is typically generated for LYTs, breaking down each type of yield source, the associated risks, and why the diversified strategy model uniquely used by SIERRA may offer a superior approach for investors seeking crypto-native yield without sacrificing liquidity.
What are LYTs?
A Liquid Yield Token (LYT) is an ERC-20 token that provides yield to tokenholders, where the yield is derived from stablecoin-denominated, income-generating assets backing the LYT.
Unlike traditional staking or yield farming where user funds are locked in smart contracts, LYTs maintain secondary market liquidity that enable LYT holders to buy or sell without locking or redeeming their capital from the underlying vault. Additionally, LYTs enable composability with CeFi and DeFi platforms, including CEXes, DEXes, lending markets, yield platforms, consumer apps and more.
As yield accrues, LYTs can either rebase or appreciate in price. Rebasing involves growing the user's balance of an LYT over time whereas price appreciation means a user's balance remains fixed but the USD value of their holdings increases. SIERRA is designed to appreciate consistently over time as yield passively accrues, which helps to enable seamless integrations across CeFi and DeFi platforms.
Types of Yield Sources for LYTs
Yield Source | Description | Historical Yield |
U.S. Treasury Bills | Short-term government securities are often referred to as the global “risk-free rate of return”, with the least credit, duration and liquidity risk | 3-4% |
Commercial Paper & Corporate Bonds | Debt instruments issued by corporations that offer higher yields in exchange for additional credit, duration, and liquidity risk | 4-6% |
Overcollateralized Lending | Lenders supply assets like USDC on DeFi platforms like Aave, Morpho, and Euler while borrowers lock up cryptoassets as collateral. Borrowers must maintain a loan-to-value threshold, where their posted collateral exceeds the value of their borrowed assets.
All borrower positions are constantly monitored and liquidated automatically if risk thresholds are breached. Since the value of the collateral exceeds the amount borrowed, early liquidation helps to ensure lenders do not experience losses. | 4-8% |
Perpetual Futures Basis | Investors earn yield by holding the underlying token and shorting its perpetual futures contract on CeFi and DeFi derivatives markets. By remaining market-neutral, this yield strategy captures the financing cost paid by leveraged traders. Compared to overcollateralized lending, basis strategies require more active management but often have higher returns. | 6-15% |
Pendle Principal Tokens (PTs) | PTs represent the principal portion of a yield-bearing asset, similar to zero-coupon bonds. Investors buy PTs at a discount to the underlying asset and are redeemed at maturity for the full amount, locking in a fixed rate of return. While PTs have secondary market liquidity prior to maturity, selling PTs early may forfeit some of the fixed yield that would be earned by holding to maturity. This yield source inherits the risks associated with the underlying assets and adds liquidity risk as capital must remain locked until maturity to accrue the yield. | 8-15% |
Under & Uncollateralized Lending | Institutional investors borrow assets like ETH and USDC from lenders and are not required to post collateral exceeding the value of their borrowed assets. Lenders must recall their assets by notifying borrowers that they request their assets returned. In the event that borrowers fail to repay the borrowed funds, traditional remedies like legal enforcement and bankruptcy may be required. This yield strategy bears similar liquidity risk as Pendle PTs since funds are locked with borrowers until repayment. Additionally, this yield strategy bears more credit risk than overcollateralized lending as lenders cannot liquidate collateral to recoup their lent assets. | 10-15% |
Market-Making Vaults | Several decentralized perpetual futures markets, often called Perp DEXes, have implemented liquidity vaults that enable borrowers to earn yield from institutional-grade market-making strategies. These vaults typically generate yield via several streams of income, including funding rate basis, platform fees, liquidation fees and trading PNL. | 8-20% |
To summarize, there are many different forms of sustainable yield generating strategies and each one has a unique risk profile. There is no free lunch, as higher yielding strategies are often accompanied by elevated forms of risk. Holders of LYTs should understand how the underlying yield is generated and the types of risk they are exposed to.