A vault is a smart contract that accepts deposits of one asset, deploys them into a strategy, and gives depositors shares in return. The strategy might be lending across several markets, providing liquidity to an exchange, staking, or running a hedged trading position. The vault handles the accounting so the depositor holds one token instead of managing a dozen positions.
Yearn Finance established the pattern in 2020 with auto-compounding strategies behind a single deposit button. The idea was that most depositors want an outcome, not a workflow, and that the workflow could be automated. Every vault since has been a variation on that proposition.
How share accounting works
A vault tracks two quantities: total assets under management and total shares outstanding. The share price is the first divided by the second. A deposit mints shares at the current share price; a withdrawal burns shares and returns the corresponding assets.
Because yield accrues to total assets while share count stays fixed, the share price rises. A depositor who put in 1,000 USDC when the share price was 1.00 holds 1,000 shares; if the share price reaches 1.05, those shares redeem for 1,050 USDC. Nothing arrives in the wallet in the meantime, which is why a vault balance that appears static is not evidence that the strategy is idle.
| Moment | Total assets | Shares outstanding | Share price |
|---|---|---|---|
| Vault launch, first deposit of 1,000 | 1,000 | 1,000 | 1.00 |
| After 50 of yield accrues | 1,050 | 1,000 | 1.05 |
| Second depositor adds 1,050 | 2,100 | 2,000 | 1.05 |
| After a further 105 of yield | 2,205 | 2,000 | 1.1025 |
The design has a useful property: a new depositor cannot dilute an existing one, because shares are always minted at the prevailing price. It also means the share price is the only performance figure that matters, and it can fall as well as rise if the strategy takes a loss.
ERC-4626 and why the standard matters
ERC-4626 is the Ethereum standard defining a common interface for tokenized vaults: deposit, mint, withdraw, redeem, plus preview functions that quote the result of an action before it happens. Before the standard, every vault exposed a slightly different interface, so each integration was bespoke.
Standardization is why a lending protocol can accept vault shares as collateral, an aggregator can route between vaults, and a wallet can display a position correctly, all without knowing what any particular vault does internally. A related standard, ERC-7540, extends the model to asynchronous vaults, where deposits and withdrawals cannot settle instantly because the underlying strategy involves off-chain settlement or a lockup.
The main types of vault
- Yield aggregator vaults move capital between external yield sources and compound the returns. The original Yearn model.
- Lending vaults allocate deposits across isolated lending markets within caps set by a curator. The dominant model on Morpho and Euler.
- Liquidity management vaults run concentrated liquidity positions on an exchange, rebalancing the range as prices move.
- Delta-neutral vaults hold spot assets hedged with a short derivatives position, earning funding rather than price appreciation.
- Tokenized fund vaults hold off-chain assets such as short-dated government debt, usually with restricted transfer and asynchronous redemption.
The type determines the failure mode. An aggregator inherits the risk of every venue it touches. A lending vault inherits its markets' collateral and oracle risk. A liquidity vault carries impermanent loss. A delta-neutral vault carries funding and counterparty risk. Reading the label tells you which questions to ask.
Where vault yield actually comes from
Every vault return traces back to one of a small number of sources, and identifying which one applies is the fastest way to judge whether a yield is durable. Lending vaults earn borrower interest, which persists as long as someone wants leverage. Liquidity vaults earn trading fees, which persist as long as there is volume. Staking vaults earn protocol rewards, which are set by the underlying network. Delta-neutral vaults earn funding payments, which persist only while the derivatives market leans one way.
A fifth source, token incentives, behaves differently from the other four. Incentives are paid in newly issued governance tokens rather than out of revenue, so the headline rate depends on the token price and on an emissions schedule that will eventually taper. A vault advertising a rate built mostly on incentives is quoting a number with an expiry date, and the sensible comparison is the rate net of incentives against a vault earning the same yield organically.
Fees
Two fee types are standard. A performance fee takes a share of the yield the vault generates, aligning the operator with returns rather than with asset gathering. A management fee charges an annual percentage of assets regardless of performance.
Caps vary by protocol. Morpho, for instance, caps vault performance fees at 50 percent of generated interest, and allows its V2 vaults an additional management fee capped at 5 percent of assets per year. Fees are usually taken by minting new shares to a fee recipient, which dilutes existing holders slightly rather than being deducted in cash.
Liquidity risk is the underrated one
The most common surprise for vault depositors is not a loss but a delay. A vault whose capital is lent into markets that are fully utilized cannot return assets until borrowers repay or new lenders arrive, regardless of how healthy the positions are. The vault is solvent; it is simply not liquid.
Well-configured vaults hold a liquidity buffer or restrict allocation to markets with headroom, accepting a lower headline yield in exchange for being able to honor redemptions. Yield-maximizing vaults do the opposite. The difference rarely shows up in the advertised rate and always shows up in a stress event.
Vaults compared with running the positions yourself
A vault charges a fee for something a depositor could do directly, so the comparison is worth making explicitly. Holding the positions yourself avoids the fee, keeps full control over allocation and removes the risk that someone else changes the strategy. It also requires monitoring every position, paying transaction costs on every rebalance, and being awake when a market deteriorates.
The economics favor doing it yourself at large size and favor the vault at small size, because gas costs and monitoring effort are largely fixed while the fee scales with capital. The judgment favors the vault when the operator genuinely knows more than the depositor about the venues involved, which is the case a curated lending vault is built on and the case a depositor should test rather than assume.
What to check before depositing
- The strategy. What does the vault actually do with the money, in one sentence you could repeat to someone else?
- The allocation. Which positions does it hold now, and how concentrated is the largest one?
- Who can change what. Which addresses hold curator, allocator and guardian style permissions, and is there a timelock giving depositors an exit window?
- The liquidity profile. How much can be withdrawn immediately, and what causes that to fall?
- The fee stack. Performance fee, management fee, and whether the underlying venues charge anything on top.
A vault that cannot be described in a sentence is not a simplification of the underlying complexity; it is a place for the complexity to hide. The curator guide covers who makes these decisions and how they are paid.