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A Principal Token (PT) offers an asset such as BTC, ETH, USDC, or DAI that is locked for a fixed term. At the end of the term, it can be redeemed for its full value.
For example, if 10 ETH is used to purchase discounted ETH at a 10% APY for a one-year lockup, 11 eP:ETH or PTs will be issued. Upon expiry of the fixed term, one year later, the 11 eP:ETH is redeemable for 11 ETH. A fixed rate of yield was secured.
The locked ETH will always be worth less than readily available ETH. Readily available ETH can be staked in a yield position, gaining active yield. For this lost opportunity, these PTs or locked ETH will be priced at a discount, likely relative to the current yield rates in the market. Purchasing this discounted ETH is akin to securing a fixed rate yield. At the time of purchase, the discount and yield are already known.
As a further example, if the current rate for staking ETH is 15% annualized variable yield, a user may sell the PTs at a slightly lower rate. This gives a guaranteed stable yield rate to the purchaser and prevents them from having to shift their assets between DeFi protocols in the situation where the variable yield decreases. Additionally, it allows users to avoid costly transaction fees and other inconvenient complexities.
Although the terminology "locked" is used to describe the process of entering a fixed yield position, it is important to note that the Element Protocol is designed to optimize for liquidity allowing users to exit their position at any time, while still enabling users to gain yield until they decide to exit.
Note: The use of 1-year terms displayed in the above examples is purely for simplicity. The Element protocol will initially allow users to mint both 3-month and 6-month terms.