Risk-Tranching

Risk-Tranching is Exponent’s primitive for splitting onchain yield assets into two different risk-return profiles. A Risk-Tranching market creates:

• a Senior tranche, for users who want a more protected form of exposure
• a Junior tranche, for users willing to take first-loss risk in exchange for higher expected returns

At a high level, the product does three things:

1. splits one underlying asset into a Senior and Junior side
2. prices the risk transfer between them through a market curve
3. defines how losses, recovery, and settlement are handled onchain

​

Core Structure

Each market is built around one underlying asset. Users deposit into either:

• Senior LP
• Junior LP

Each deposit mints LP shares for the selected tranche. LP shares represent a proportional claim on that tranche’s effective NAV, not only on the raw amount deposited. This means new deposits are priced against the current state of the tranche.

​

LP share example

If the Junior tranche has:

• 1,000 LP shares
• $1,200 effective NAV

and a new user deposits $120, that user receives:

• 120 / 1200 × 1000 = 100 LP shares

Total Junior LP supply then becomes 1,100 shares. If the tranche NAV has gone up, new users receive fewer shares for the same deposit. If the tranche NAV has gone down, share value reflects that loss.

​

What Senior and Junior Economically Represent

The tranches sit in different places in the loss waterfall.

​

Coverage and Utilization

The two most important variables in a Risk-Tranching market are coverage and coverage utilization.

​

Coverage

Coverage refers to how much Junior capital is available to protect Senior. In normal terms:

• higher coverage = stronger protection for Senior
• lower coverage = thinner Junior protection

​

Coverage utilization

The program tracks this through coverage utilization. A simple way to think about it is: coverage utilization = required junior coverage / actual junior effective NAV Where:

• 100% utilization means the market is exactly at its minimum required protection level
• below 100% means the market has more protection than the minimum
• above 100% means the market is under-covered

So:

• lower utilization = healthier market
• higher utilization = tighter market
• above 100% = protection has fallen below the minimum required level

​

Minimum Coverage and Target Coverage

Each market is configured with a Minimum Coverage and a Target Coverage.

​

How the Yield Split Works

Risk-Tranching markets do not use a fixed Senior / Junior yield split. Instead, the split is determined by a return curve that depends on utilization:

• when Junior protection is abundant, Junior should earn a lower premium
• when Junior protection becomes tight, Junior becomes more valuable and should earn a higher premium

The market prices protection dynamically.

​

Return Curve Types

Exponent supports multiple ways to define how the Junior share changes across utilization.

​

How the Risk Premium Is Determined

The risk premium is the yield Senior gives up to Junior in exchange for protection. In simple terms: Risk premium = underlying yield - senior yield That premium is transferred to Junior, subject to the market curve and any protocol spread.

​

Example

If the underlying asset yields 11.84%and Senior earns 6.60%then the gross premium transferred away from Senior is: 11.84% - 6.60% = 5.24% That premium is transferred from Senior to Junior, but because Junior is usually a smaller capital base than Senior, the effect on Junior APY is amplified. In practice, this is what gives Junior its leveraged return profile relative to the underlying asset.

​

How Gains and Losses Are Recognized

Risk-Tranching markets do not estimate NAV continuously in the background. Instead they rely on an approved NAV or pricing source for the underlying asset. When the market is synced through an onchain instruction, it compares:

• the latest underlying NAV
• the last recorded market state

and applies the difference. This means positive NAV changes are recognized as gains, while negative NAV changes are recognized as losses. These effects are applied on sync, not continuously every second. In practice, sync happens through actions such as:

• deposit
• withdrawal
• market update
• parameter update

​

Loss Waterfall

Losses are not shared equally between both tranches. They are transferred in order.

1. Junior absorbs losses first
   If the underlying asset suffers a negative NAV event, Junior is the first tranche to absorb that loss.
2. Senior is affected only after Junior is exhausted If the loss is larger than the available Junior protection, Senior begins taking loss as well. This means the protection Senior really has depends on the amount of Junior effective NAV available at the time of the event.

​

Loss Example at 22% coverage

• If the market has 22% effective Junior coverage
• and the underlying asset suffers a 15% NAV loss

then Junior absorbs the full 15% loss first, leaving 7% coverage. Senior remains whole, but the market is now much tighter.

• If the underlying instead suffers a 25% NAV loss

then Junior absorbs the first 22%, and Senior takes the remaining 3% loss.

​

Recovery Period

Not every covered loss should necessarily be settled immediately. If Junior has covered a Senior-side loss, Senior remains whole, and the market is still below its settlement threshold, the market can enter a Recovery Period. The Recovery Period is designed to handle losses that may be temporary rather than permanent. During the Recovery Period:

• Senior stops receiving yield
• Senior withdrawals are paused
• Junior may recover some or all of the covered loss if the underlying NAV rebounds

This is meant to avoid crystallizing temporary losses too quickly.

​

Settlement Threshold

If the market moves beyond its configured settlement threshold, the Recovery Period is skipped and the market moves directly into settlement. This is intended for more severe losses, and in that event:

• Junior is settled to protect Senior
• the loss is realized
• the market returns to a normal state after settlement

​

Settlement threshold formula

The settlement threshold is not configured independently. It is derived from:

• Minimum Coverage
• Settlement Utilization

If:

• Minimum Coverage = 20%
• Settlement Utilization = 110%

then settlement begins once effective coverage falls below: 20% / 1.10 = 18.18% So the market can tolerate some deterioration below the minimum before forcing immediate settlement.

​

Example: settlement threshold

• If the market starts at 22% coverage
• and the underlying asset suffers a 3% NAV loss

then remaining coverage becomes: 22% - 3% = 19% This is below the 20% minimum, but still above the 18.18% settlement threshold, so the market enters Recovery Period to assess if the loss is long-term or temporary.

• If the underlying instead suffers a 5% NAV loss
• then remaining coverage becomes:

22% - 5% = 17% This is below the settlement threshold, so the market skips Recovery Period and moves directly into settlement.

​

Senior and Junior Exit Constraints

The two tranches do not always have the same exit behavior.