These new PYTs allow liquidity providers to access the emerging DeFi uncollateralized loan market with senior and junior risk-adjusted profiles.

The DeFi uncollateralized loan market

On one hand, overcollateralized loans are one of the tenets of DeFi. They addressed the quest to eliminate centralization bottlenecks for the loan market: you do not have to source potential lenders or negotiate the interest rate since there is a single entry point for all loans, and the interest rate is determined algorithmically from market conditions. These lending/borrowing protocols work autonomously without reputation and borrowers use collateral in excess of the value of the borrowed assets (which function as a guarantee to cover potential losses in default cases).

On the other hand, uncollateralized loans, a missing piece in the DeFi puzzle, are finally coming to open finance. While this new component is opening up to better capital efficiency and countless applications for DeFi, it comes with a significant challenge: appropriately managing risk exposure.

Enter risk tranching. At a high level, investors can choose between different risk levels — each with its own tailored potential for upside and downside — when depositing their digital assets into a specific pool. Tranche lending products are widely used in traditional finance and offer a pathway to risk management for decentralized debt. Essentially, it allows risk to be redistributed among different investor profiles.

Uncollateralized Perpetual Yield Tranches

Perpetual Yield Tranches (PYTs) are a new risk-hedging DeFi primitive that allows investors to select the risk-return profile they’re more comfortable with. PYTs come in two different classes: Senior and Junior. With these classes, investors can earn yield optimized by their risk level.

Uncollateralized loans are part of the next iteration of DeFi, but currently lack hedging instruments. That’s why Idle DAO has partnered with Clearpool to build PYTs on top of their ground-breaking uncollateralized single-borrower pools, starting with Wintermute’s pool, cpWIN-USDC.

About Clearpool

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