Principal Token
TL;DR: Liquidity providers who seek to underwrite risk can mint Principal Tokens + Swap Tokens, to earn a fixed premium from the sale of the Swap Tokens. The Principal Token represents the proportional ownership of principal in the Cork Pool.
Introduction
In Cork, Swap Token holders pay a premium to Principal Token holders in exchange for them underwriting the risk which is hedged with the Swap Tokens. Principal Tokens represent the primary underwriting token and is the main "yield strategy" for liquidity providers in Cork.
How Principal Tokens Work
In a Cork Pool, a Collateral Asset can be deposited to mint two tokens: Swap Token + Principal Token. The Principal Token represents the fractional ownership of the principal in the Cork Pool. At expiry, the Principal Token holder can claim the assets (including yield generated by the Collateral Asset). If Swap Tokens have not been exercised, the Principal Token holder receives back the original Collateral Asset. If Swap Tokens have been exercised, they could receive a combination of Collateral Asset and Reference Asset (which may be impaired or face duration risk). As such, the Principal Token holder is effectively exposed to the performance of the Collateral Asset and Reference Asset, if either is impaired through the expiry, the underwriter may face a loss.
Underwriters furthermore can earn a fixed yield by selling the Swap Token in exchange for a premium. Effectively, the premium is the price which Swap Token holders are paying for the liquidity and hedging facility provided to them my the underwriter. In other words, the price of the risk.
At any time before expiry, combining Principal Token + Swap Token can effectively reconstitute the Collateral Asset at a 1:1 ratio, thus unwinding the exposure.
Yield Sources
Principal Tokens can earn a yield through a variety of sources:
Collateral Asset yield: The native yield of the Collateral Asset (such as sUSDS or wstETH) accrues to the Principal Token holder.
Premium: The fixed yield earned by selling minted Swap Tokens.
Fees: In some Cork Pools, the fee revenue from the Exercise Swap fee and Repurchase Fee may flow to Principal Token holders
Incentives: Token incentives from partners and Cork generally accrue to Principal Token holders.
Rehypothecation: The Principal Token represents quality collateral in many cases, which can compose with other DeFi building blocks such as lending markets to perform looping trades to amplify yield.
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