One of the most exciting characteristics of DeFi is the composability (i.e. modularity) it offers to projects building in the industry. Thanks to the permissionless nature of smart contracts, teams are able to create products and strategies on top of each other in inventive ways.
For this purpose, many Dapps host a variety of vaults in which users can deposit into strategies, receiving a deposit token in return. These tokens are just like any other ERC-20 token and can be transferred or traded wherever there is a market for them.
To take a simple example, by collecting funds from many users, a DeFi protocol can repeatedly re-invest the earnings received from another project, a practice known as compounding. This increases the amount deposited, leading to increased earnings, which are then reinvested, and so on. Strategies allow users to earn whilst pooling the gas fees necessary for regular compounding. This way, users are able to realise a higher return than they would be able to with their own funds.
The underlying yield may come from lending, providing liquidity, writing options, etc. and, despite being continuously accumulated by the strategy, remains represented by the tokens that the user initially received when depositing into the strategy.
Although the user receives no further deposit tokens after their initial deposit, the value of these tokens is constantly increasing, hence the name yield-bearing tokens. When the time comes for the user to withdraw funds from the strategy, they will receive more of the asset that they originally deposited.
On Stake DAO, the underlying yield of each strategy is ‘harvested’ multiple times per week. This increases the value of the deposit tokens, and the Price Per Share can be tracked on the Strategies tab.
By multiplying the number of Shares (e.g. of sd3Crv) by the Price Per Share, and then by price of the underlying asset (in this case the virtual price of 3Crv on Curve) the value of one’s investment can be tracked.
At the time of writing, 1000 sd3Crv, at a the current Price Per Share of 1.082 and 3Crv virtual price of $1.02, would be worth:
1000 * 1.082 * 1.02 = $1103.64
Yield-bearing tokens are also used by projects to continuously distribute protocol earnings to their users via governance tokens. For example, on Stake DAO, it’s possible to stake SDT, receiving xSDT in return. This is a yield-bearing token that, as well as allowing users to vote, earns a portion of the fees generated across the Stake DAO platform.
A note on token names:
Given the way that many strategies use other project’s assets, it’s common to see complicated token names representing the ways in which these strategies and projects are stacked like Lego blocks.
We can often differentiate between tokens according to the prefixes used, for example: sdam3crv
This token represents deposits into Stake DAO’s Passive Aave USD Strategy in which stablecoins (USDC, DAI, USDT) are deposited in the Curve Aave 3pool on the Polygon (Matic) Network. The am3crv LP tokens are then stacked into StakeDAO’s strategy, resulting in the sdam3crv Shares.
This token represents the stacking of 3 protocols (Aave, Curve and StakeDAO) that we can see in the name of the final token.