# What is Covenant?

Covenant is a fully on‑chain and permissionless protocol for tranching risk on tokenized vaults. Any asset with a price oracle can be deposited into a Covenant Market and split into two fungible ERC‑20 claims:

* a **senior tranche** (a **Yield Coin**), a fully collateralized debt claim that earns a market‑determined yield; and
* a **junior tranche** (a **Leverage Coin**), an equity claim that pays funding to the senior in exchange for leveraged exposure to the underlying.

Both tranches are fully collateralized against the deposited Base Asset and redeemable to it at any time. The split is permissionless and works:

1. for any oracle-priced collateral, including volatile assets (ETH, WBTC), yield-bearing assets (stETH, sUSDe), and tokenized RWAs;
2. without governance‑set interest rates;
3. without requiring a stablecoin liquidity pool; and
4. without per‑position liquidations.

## Two audiences, one market

Covenant Markets clear two natural counterparties against the same collateral pool:

* **Yield seekers** (treasuries, stablecoin DAOs, fixed‑income allocators) hold Yield Coins. The senior claim is first in the waterfall and earns funding paid by junior holders.
* **Leverage seekers** (structured product issuers, leveraged-yield vaults, directional traders) hold Leverage Coins. The junior claim is a single ERC‑20 with embedded leverage. There is no recursive deposit/borrow loop, no liquidation price to monitor, and no per‑position margin account.

Lenders who prefer diversified senior exposure across markets can instead hold the **Covenant sUSDz Yield Fund** receipt token (`$sUSDz`), which holds a portfolio of Yield Coins denominated in USD.

## Where the yield comes from

Each Covenant Market is designed around a **target LTV**. At the target, the value of the collateral pool splits cleanly between the two tranches:

$$V\_B = V\_Y + V\_L$$

where:

* $$V\_B$$ = Base Asset NAV (mark-to-market value of the collateral pool);
* $$V\_Y$$ = Yield Coin NAV (par debt outstanding to senior holders, also called the notional);
* $$V\_L$$ = Leverage Coin NAV (residual claim on collateral at target LTV).

A market at 80% target LTV splits $100 of Base Asset NAV into $80 of Yield Coin NAV (senior debt at par) and $20 of Leverage Coin NAV (junior equity, levered 5x). At the target, each tranche's market price equals its NAV.

Funding flows continuously from the junior tranche to the senior tranche. Both the funding rate and the market price of each tranche are set by an on‑chain market relative to the tranche's NAV. When the market moves away from target LTV, Yield Coins trade at a discount to NAV (the discount *is* the yield) and Leverage Coins clear at the corresponding price.

Because senior yield is generated by leverage demand against the AMM rather than a slice of the underlying's yield, a Covenant Market can be deployed against any oracle-priced asset, including non‑yield‑bearing collateral (raw ETH, WBTC) and tokenized vaults with redemption windows (RWAs). The full mechanism is described in [How tranching works](/protocol-mechanism/how-does-covenant-work.md) and [The Latent Swap AMM](/protocol-mechanism/latent-swap-amm.md).


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