What are principal tokens and why they matter in DeFi

Principal Tokens split yield-bearing assets into principal and yield, enabling fixed returns in DeFi.

Principal Tokens (PTs) are a financial primitive that splits a yield-bearing asset into two separate, tradable components: one representing the principal and the other representing all future yield. This separation enables fixed-rate returns, yield speculation and on-chain structured products –  all without centralized intermediaries.

The mechanism creates two tokens:

• Principal Token (PT) –  a claim on the underlying deposit, redeemable at maturity
• Yield Token (YT) –  a claim on all yield generated by that deposit until maturity

Pendle popularized this approach, though earlier yield-splitting designs appeared in Element Finance, APWine, Tempus, Swivel and Yield Protocol.

How Principal Tokens work

Imagine depositing 1,000 USDC into an Aave, earning roughly 6% APY. A PT/YT protocol can split this yield-bearing position into two tokens:

• PT-aUSDC – a claim on the principal, redeemable for 1,000 USDC at maturity
• YT-aUSDC – a claim on all yield generated by that deposit until maturity

After the split, PT and YT trade independently. PTs typically trade at a discount because they offer a fixed payout at maturity, while YTs capture the variable, uncertain yield.

This separation is what enables the core use cases of PTs.

Fixed yield through discounted PTs

Buying PTs at a discount is the simplest and most common strategy. If a one-year PT-aUSDC trades at 0.94 USDC, the buyer effectively locks in a fixed return of about 6.4% when it redeems at 1.00 USDC at maturity.

This works like an onchain zero-coupon bond, where the discount represents the implied yield. During periods of rate uncertainty or market stress, PTs often become some of the most attractive fixed-income instruments in DeFi.

Speculating on yield with YT

YT holders are exposed solely to future yield. When implied yields in the market are low, YTs can trade at very low prices relative to potential payouts. If actual yields later rise, the value of YT can increase sharply, in some cases multiplying many times when rates move strongly.

This strategy is popular among advanced traders who want targeted exposure to interest-rate changes rather than to the underlying asset.

Hedging yield exposure

PT/YT mechanics enable customized risk management. For example, a stETH holder who wants to protect the principal value while minimizing yield volatility can:

• sell the YT-stETH portion, removing exposure to variable future yield
• keep the PT-stETH portion, which guarantees the principal value at maturity

This preserves the principal and reduces rate risk while still allowing predictable returns.

Risks and considerations

• Pre-maturity pricing: PT prices can fluctuate before maturity as implied yields change, even though they converge to par at expiry for holders who remain until the end.
• Contract risk: Principal redemption is enforced by the protocol, but smart contract risk still applies as with any DeFi system.
• Yield opportunity cost: Hedging principal exposure limits upside if yields rise unexpectedly, which is inherent to fixed-income positioning.

Building structured products

Because PTs provide a predictable payout floor at maturity, they serve as a core building block for various structured products, such as:

• principal-protected vaults
• “shark-fin” strategies with conditional upside
• rate-enhanced auto-compounding products
• callable yield structures

The PT establishes the baseline return for the strategy, while additional components - such as YTs, options or dynamic rebalancing - define the potential upside.

Arbitrage and basis trading

Professional traders and institutions monitor PT markets for yield mispricing. When the discount on a PT implies a return that exceeds their cost of capital, buying PTs becomes an attractive basis trade. The position pays out at maturity, making it lower-risk compared to most DeFi strategies when held to term.

This type of activity is especially common in stablecoin markets, where PTs such as USDC or USDT maturities provide clearer yield signals and deeper liquidity.

Market landscape 

As of the latest available data, Pendle remains the largest yield-tokenization protocol in DeFi by total value locked (TVL), with roughly $3.7 bln in aggregated smart-contract liquidity according to DefiLlama.

This dominant TVL reflects Pendle’s strong position in the PT/YT ecosystem, where it tokenizes future yield into tradable Principal Tokens (PTs) and Yield Tokens (YTs), enabling fixed income, basis trading, and advanced yield strategies.

Key PT markets active in Pendle include:

• Stablecoin PTs such as PT-USDC or PT-USDT maturities, often featuring compelling implied yields depending on market conditions (e.g., integrations like Ethena’s USDe have driven activity historically).
• Liquid staking-derived yield PTs such as PT-stETH and other LST/PT pairs.
• GLP-linked pools tied to GMX strategies, where GLP yield is tokenized via Pendle.
• Emerging PT markets built on LRTs and other staking abstractions.

As liquid-staking tokens (LSTs), liquid reward tokens (LRTs) and stablecoin yield assets expand across DeFi, PT markets have become central venues for pricing on-chain interest rates and yielding products. Pendle’s continued liquidity and the composability of PT/YT positions have established it as a core piece of the growing decentralized interest-rate market infrastructure. 

Stay tuned for upcoming guides designed to shed light on how DeFi works!