DeFi, for all its permissionless liquidity and non-local trading advantages, still faces a major architectural flaw, one that has continued to cost liquidity providers millions of dollars annually. To elaborate, traditional automated market makers (AMMs) like Uniswap and Curve are primarily designed for static tokens that can maintain relatively stable relationships with one another or at least fluctuate in predictable patterns.
What they weren’t built for, however, are assets that appreciate over time via certain yield generation mechanisms. As a result, when yield-bearing stablecoins (YBC) are deposited into these pools, something peculiar happens wherein they continue to accrue value through staking rewards, funding rate spreads, or other yield-generating mechanisms.
Existing AMMs, however, have no means of recognizing or capturing this growth, leaving these rewards vulnerable to arbitrage. For instance, a review of Uniswap v3’s pool performance (covering 43% of its TVL) reveals that liquidity providers generated $199.3 million in trading fees, yet at the same time experienced a net loss of $60.8 million relative to simply holding their original assets.
This is because arbitrageurs monitoring these pools can detect price discrepancies within seconds, executing trades that extract the accumulated yield from the pool, effectively transferring value that should have belonged to the liquidity providers into their own pockets (often multiple times per block during periods of high market activity).
What makes this even more insidious is that liquidity providers may not even realize they’re losing value, as their token balances remain unchanged but the losses continue to manifest (not in quantity but in the opportunity cost of the foregone yield).
Mounting hidden costs can become burdensome, quick!
In addition to impermanent loss, the issue of capital efficiency is also a major problem. And, while platforms like Uniswap v3 have tried to allay these issues using the idea of concentrated liquidity (which enables liquidity providers to concentrate their capital within specific price ranges), the innovation falls short for yield bearing stablecoins.
This is because their optimal range constantly shifts, forcing providers into a perpetual rebalancing act so much so that missing a single window can result in liquidity becoming idle, earning neither trading fees nor maintaining exposure to the asset’s yield.
This is where Terminal Finance’s architecture differs from conventional frameworks, i.e., rather than attempting to retrofit traditional AMM mechanics to accommodate yield-bearing assets, its yield skimming mechanism treats any accumulated yield not as a price discrepancy to be arbitraged away, but as legitimate revenue belonging to the liquidity pool itself.
So, for example, when Ethena’s sUSDe or other similar stablecoin pools generate returns, that yield is captured systematically and redistributed according to a set of predefined allocation rules. Liquidity providers receive their proportional share while a portion flows to the protocol and token holders, creating aligned incentives across all stakeholders.
In other words, instead of watching arbitrageurs extract value that rightfully belongs to them, liquidity providers on Terminal benefit directly from the native yields of their deposited assets while simultaneously earning trading fees and protocol incentives. This tri-fold revenue stream of native yield, trading fees, and governance token rewards creates an economic model that can sustainably compete with centralized alternatives without relying on unsustainable token emissions or promotional rates.
In fact, thanks to this novel setup, Terminal’s pre-deposit phase attracted over $280 million in committed capital (across USDe, WETH, and WBTC vaults) within sixty days of its launch. Not only that, the platform currently stands as the most traded asset on Pendle by volume and the largest protocol by TVL within the Ethena ecosystem.
Looking ahead toward an increasingly digital future
From the outside looking in, the broader crypto market has been shifting toward YBS as investors continue to seek out uses for their capital beyond speculative trading alone. Similarly, trad-fi institutions are taking notice as well, with BlackRock’s BUIDL fund backing USDtb, a tokenized Treasury product that Terminal supports as a base trading pair.
Looking ahead, it stands to reason that the next evolution of DeFi will recognize that not all assets are created equal and that treating them identically (in protocol design) can and will lead to suboptimal outcomes for everyone except arbitrageurs. Interesting times ahead!
Disclaimer: The content on this site should not be considered investment advice. Investing is speculative. When investing, your capital is at risk.
Featured image via Shuttertsock.
