For those active on LUNA-tics Twitter, I’m sure you’ve seen posts regarding Prism, a new Terra project with the goal of “refracting and revolutionizing DeFi.” Given little information yet provided by the team, I recently tried my best to figure out what this project could look like through a thread on Twitter. However, my assumption about how it worked from a technical standpoint turned out to be incorrect. Primed with slightly more information, I am going to revise my analysis and breakdown how this project will work.
Prism creates a mechanism in which you can provide your $LUNA token and receive two derivatives: A principal token (PT) and a yield token (YT). As the name suggests, the PT allows the user to speculate on only the price action of the token whereas YT allows the use to speculate only on the future staking yield. By giving the ability to separate the riskiness of price speculation from the stability of staking yield, Prism creates brand new use cases in DeFi.
For both PT and YT, there will be time intervals for which the derivatives will expire. The team highlights 3, 6, and 12 month intervals, however there may be more to choose from in the future. The time intervals are important because they represent the monetization of yield for that time. For example, if we assume $LUNA staking rewards are expected to be a constant 10% APY, the YT for a 12 month interval represents the current monetary value of that 10% (given APY represents yearly returns). Because total staking rewards are lesser for shorter time periods, as the derivates get closer to maturity we can expect the YT values to converge to 0 as the rewards are paid out and the PT values to converge to the price of $LUNA. At the end of this time interval, the owners of PT are able to directly swap 1:1 their PT to the $LUNA set as collateral.
So what value do these bring? Here are some of the basic use cases.
Liquidation-Free Leverage
Because the pLUNA always trades at a discount to LUNA, and at maturity these can be swapped 1:1, you can get higher exposure to LUNA for a fraction of the cost. You are essentially “loaning” out your yield to leverage up on the price action of LUNA. If you want to participate, you can either provide $LUNA to Prism and immediately sell your YT and use that capital to purchase more PT, or you can just buy PT on the open market for a discounted price versus $LUNA.
Upfront Monetization of Future Yield
As mentioned earlier, the YT represents the future value of staking rewards at this particular point in time. So if you put your $LUNA into the prism smart contract, you can sell off your YT to receive immediate monetization of future yield for the specified time interval. For example: If you have $10 worth of LUNA locked in Prism and the 12 month YT is trading at an implied yield of 10%, you can be rewarded with an immediate $1. Inversely, you can sell your PT if you don’t want any risk of price action but want strictly the yield coming from POS validation.
Yield Curve/Trading
In my past analysis, I compared the value YT to that of a bond. However I assumed there would be some underlying principle that could be redeemed at maturity, which is not the case. The way in which they are comparable is through the yield they provide. Given differing time intervals to maturity, the yields of various YT will provide a yield curve for each asset. In traditional markets, yield curves are often a straightforward and simple metric for macro investors to get a gauge of the markets expectation of future growth and inflation. An upward curve represents growth or increased inflation, and a downward curve represents the opposite. Here’s a clip of Raoul Paul explaining the yield curve and why he loves trading bond yields:
So what do yield curves mean for the crypto market? It’s tough to tell at the moment, and will likely vary across assets given where their yield is coming from (inflation, fees, airdrops, etc.). For now, I assume for POS assets it will likely reflect the expected economic activity and/or inflation on a given blockchain over the given time period, similar to bonds, but it’s likely with a whole new asset class there will be different insights to gleam from this data.
Similar to how entities are currently able to trade yield through bonds or interest swaps, this will also open up the door to a new set of trading strategies not seen in the crypto markets to date. The most basic example: Let’s say the current expected 12 month yield is trading at 10%, and you think $LUNA staking rewards are going to increase in that time period. If you buy $10 worth of that YT, and the expected staking rewards increase to 20%, assuming no discount rate that would turn into $20. These can obviously get more complicated once you factor in discount rates, trading across time intervals, supply and demand of the tokens themselves, etc.
Liquidity Providing
There are many risks involved when yield farming and providing liquidity for DEX’s that stem strictly from the principal of a token. This is both in the form of the token losing its value for downward price and impermanent loss for increased price. As a result, DEX’s need to provide extremely large yield to attract users to provide liquidity on their platform. By removing the need for principal, YT reduces the strain on DEX’s to provide yield and reduces the providers exposure to price risk. This is going to work extremely well for forms of liquidity with decreased risk of impermanent loss, such as with concentrated liquidity or correlated assets (pLuna — LUNA for example).
Closing
Prism may be the project I’m most excited about in the Terra ecosystem. With a brand new set of derivatives I don’t think it’s potential stops with these use cases, I see this making a large impact on the DeFi landscape. This will certainly be a project I’ll be communicating with as they roll out development, so keep an eye out for future articles going into more detail about specific use cases or the mechanism in which the protocol works.
Check out their Twitter and Medium pages (@prism_protocol, PRISM) for more information coming soon. If you enjoyed the content, consider following my Twitter @WestieCapital, and if you have any questions my DM’s are always open. Cheers.
