Oct 18, 2025
As investors explore new opportunities across the cryptoasset industry, earning yield has become an important focus. For yield-focused users, the relatively new vertical of Liquid Yield Tokens (LYTs) has become more prominent. This new vertical has many different projects where each LYT differs in user experience, token utility, reserve management strategy and risks associated.
In this article, we’ll break down the types of risks associated with LYTs and explain Sierra’s approach to risk management.
Key Risks of LYTs
The table below outlines eleven prominent risks that LYT issuers often face when implementing their reserve management strategy:
Risk Types | Description |
Duration Risk | Risk that an interest rate change causes the value of the reserve assets to change |
Credit Risk | Risk that the issuer or obligor of the bonds, debt or other forms of yield default on their interest payments or overall debt obligations |
Liquidity Risk | Risk that an LYT's reserves will incur loss through withdrawing, redeeming or recalling reserve assets from a yield source |
Term Risk | Risk that reserve assets in a yield source are completely illiquid until the term or deposit period expires, which may cause an LYT to not be able to meet all of its redemption obligations in a timely fashion |
Currency Risk | Risk that reserve assets are deployed in a yield source denominated in another currency than USD and that currency depreciates against USD. Additionally, there is a similar risk that a yield source relies on a different USD-denominated stablecoin than USDC and it depegs below $1 |
Yield Volatility Risk | Risk that the floating-rate yield sources vary from the initial rate that reserve assets were deployed |
Smart Contract Risk | Risk that bugs or vulnerabilities in the underlying smart contracts for DeFi yield sources result in partial or full loss of reserve assets deployed |
Exploit Risk | Risk that a malicious actor uses a DeFi yield source in an unintended way that results in partial or full loss of reserve assets deployed |
Financial Crime Risk | Risk that a high-risk entity (i.e. sanctioned wallets or darknet marketplace users), based on wallet scoring by AML analytics platforms, comingle their assets in a DeFi yield source that an LYT has reserve assets deployed into |
Regulatory Risk | Risk that regulators sue, or take similar action, against one of the DeFi yield sources that an LYT has reserve assets deployed into |
Correlation Risk | Risk that problems with one yield source could trigger issues in another, making additional losses more likely to happen |
Sierra’s Risk Framework and Reserve Management Strategy
Each yield source included in Sierra’s reserve management strategy is assessed using Sierra’s risk framework. This process involves a detailed analysis of the applicability of these 11 risk types for each yield source. Once analyzed, each yield source is scored on a risk rating of None, Low, Material, High or Prohibitive. The higher the risk rating implies a larger discount is assessed to the yield source.
Additionally, discounts corresponding to more significant risks are given a higher weight in the framework. For example, credit risk or smart contract risk materializing will likely have a more significant negative impact on Sierra’s reserves than yield volatility. This is because a counterparty defaulting or DeFi yield source being hacked will result in a loss of reserve assets versus the relatively lower impact of yields on reserve assets falling.
A final component of the risk framework is the parameter of Maximum Portfolio Allocation, which limits the amount of SIERRA's reserves that can be deployed into a given yield source. This extra layer of risk management ensures that SIERRA's portfolio of reserve assets does not become too overweight yield sources with higher risk.
Combining the discounting factors with the weighting methodology and maximum portfolio allocation enables the risk framework to transform current yields to risk-adjusted yields, which are now directly comparable. For example, earning 12% via uncollateralized lending on Wildcat is not directly comparable to earning 4% on U.S. Treasury bills as we must discount the 12% rate of return for credit risk and other applicable risk types.
Sierra’s reserve management strategy is executed by sorting the risk-adjusted yields from highest to lowest, allocating to the highest yield source up to its corresponding maximum portfolio allocation and continuing downwards until the portfolio is fully allocated. Additionally, Sierra’s reserves are dynamically rebalanced each day by recomputing the risk analysis from the risk framework and adjusting the reserve management strategy accordingly.
More information on Sierra’s Risk Framework and Reserve Management Strategy are available here: https://docs.sierra.money/reserves-management/risk-framework.
Conclusion
LYTs have a complex risk profile based on their underlying reserve management strategy. Since the Sierra protocol has the most flexible reserve management strategy across all major LYTs, it has developed a comprehensive risk framework to adequately analyze yield sources for all major risk types and compute risk-adjusted yields. This approach, combined with industry-leading transparency via the Transparency Dashboard, enables users to make informed decisions when holding SIERRA.