Adaptive Yield Split: liquidity scalability for Perpetual Yield Tranches

Idle Leagues are thrilled to introduce the Adaptive Yield Split on PYTs: a new way to achieve capital efficiency!

AYS introduces improvements that allow scaling of Senior/Junior liquidity and improving APY. It can be applied to all PYTs without changing the current infrastructure. With the implementation of the Adaptive Yield Split (AYS), PYTs’ users will obtain yield in new ways depending on their tranche:

• Senior Tranche: Receive most of the underlying yield when liquidity is low on the Junior side (i.e. low coverage on Senior funds), or receive a guaranteed minimum portion of the underlying yield, when Junior liquidity is high (i.e. high coverage on Senior funds);
• Junior Tranche: Receive outperforming APYs on the Junior Tranches, no matter what the amount of deposited liquidity on the Senior is.

Leagues started working on these PYTs improvements with the following research questions:

• How to select a yield source that has a risk profile that justifies the built-in coverage feature of Senior?
• How to incentivize the Senior if there isn’t sufficient liquidity in the Junior?
• How to guarantee overperforming APYs on the Junior side, no matter the TVL ratios between Junior and Senior Tranche?
• How to efficiently bootstrap multiple pools using Gauges?

The Adaptive Yield Split comes to help here by addressing the majority of these challenges. In the article, we present the AYS model innovation vs the current fixed split model and later focus on the PYTs challenges and how the AYS is able to tackle them.

Current Model vs AYS Model

Yield generated with the existing model is reflected in the diagram below (log scale), assuming an underlying yield equal to 10%. “Junior TVL ratio” is the percentage of Junior liquidity compared to the total pool liquidity.

Senior LPs receive a yield lower than half of the underlying (5% APY) in most cases. Senior/Junior APY parity is reached only when their liquidity ratio is equal to the yield split ratio (e.g. 90% of the yield to Junior, 10% to Senior).

The Adaptive Yield Split changes these dynamics, empowering Senior LPs to receive the majority of the generated yield when there is low fund protection (low Junior liquidity). Consequently, the Senior yield is overall higher than the previous yield distribution methodology.

This mechanism is particularly efficient with protocols carrying many dependencies/risks, which are generally associated with higher APYs. As an example, leveraged stETH strategy fits this condition. The underlying APY is approximately 10%, and Senior LPs would be able to receive at least 5% APY natively on ETH while protecting their capital from liquidation risks.

On the Junior side, AYS unlocks liquidity scalability: LPs can deploy any size of funds, and the PYTs self-adjust the yield split.

Current PYTs’ challenges

During the last months, Idle Leagues identified 4 different PYTs’ scalability challenges:

1. Yield source selection: choosing the right underlying protocol is crucial to build PYTs that provide adequate coverage protection for the Senior, and a compelling APY for the Junior. If the yield source is perceived as battle-tested, then the built-in protection feature will not generate enough interest in the community. The downstream yield generated by established protocols is low due to saturated market capacity: consequently, the Senior APY will underperform the overall DeFi market returns.
2. Senior coverage asymmetry: when liquidity providers deploy funds into a Senior PYT, they forward most of the accrued yields to the Junior. This is in exchange for protection, that is not yet available (Junior APYs are very high, but liquidity is low). This scenario disincentivizes Senior liquidity providers to hold their position.
3. Junior liquidity depth: With the current fixed yield split, Junior can accommodate limited liquidity to guarantee an outperforming return compared to the underlying yield. Furthermore, Junior deposits dilute the APY of existing pool participants.
4. Gauges weights concentration: PYTs are currently incentivised by IDLE rewards on top of the underlying yield. This incentive is beneficial to onboard initial liquidity and retains the existing one. At the same time, the concentration of governance token rewards into a single Senior PYT limits other pools from receiving part of this stream. Bootstrapping a new market becomes challenging due to the lower underlying APYs.

A strategic approach to solve the liquidity chicken-egg problem

For the first challenge (Yield source selection), the setup of a framework would help Idle identify the protocols able to maintain high APYs while increasing the managed liquidity.

This new model addresses the limitations reported in challenge 2, 3, and 4.

With the AYS mechanism, Senior LPs will earn about the same yield generated by the underlying source. Once Junior deposits start to add up and generate coverage, the Senior yield decreases but the APY will always remain above the underlying one by design (Senior coverage asymmetry).

Additionally, Junior Tranches will always receive outperforming APYs, no matter what the amount of deposited liquidity on the Senior is (Junior liquidity depth).

The IDLE Gauges can then be split across a more comprehensive number of Senior PYTs, as their organic yield is already high (Gauges weights concentration).

The graph below showcases how Senior PYTs can provide increased APYs thanks to IDLE Gauges. In the reported case, $2.5m TVL is deposited on the Senior Tranche, which receives 30% of the IDLE emission. The underlying APY is equal to 10%. Yields vary from 7%, when Senior funds are covered by an equal amount of Junior liquidity up to 12% when Senior liquidity is predominant.

Practical application of the Adaptive Yield Split

The first PYTs implementing the AYS are almost ready to go! They will be based on a new lending market, which uses innovative frameworks to improve the resilience of the oracles against market manipulation 👀

They will be launched on USDC first and extended to other stablecoin and ETH-based markets in the following weeks.

Join our Discord to guess who is the targeted yield source, stay tuned!