ERC-20 Tokens that represent a 1-1 claim for underlying upon maturity.
Principal tokens, PTs, are ERC-20's which are redeemable 1:1 at maturity for an underlying token.
As users lock-in fixed yields, their deposit is split into PTs and YTs (yield tokens) and the the YTs minted are sold to fuel a fixed-yield.
This leaves the lender with an immediate fixed-yield and their minted PTs.
Alice has 1000 USDC.
Alice fills Bob's order, splitting 1000 USDC into 1000 ptUSDC and 1000 ytUSDC.
Alice sells 1000 ytUSDC to Bob for 50 USDC.
Alice then has 1000 ptUSDC. At maturity Alice redeems her 1000 ptUSDC for 1000 USDC.
This leaves Alice with 1050 USDC.
Lending 1000 USDC at 5% for 1 Year
Given PTs represent a 1-1 redemption only upon maturity, they are discounted at a rate based on the predicted amount of interest that may have otherwise been generated until the maturity/redemption date (the YT price).
Accepting that this potential yield decreases as time passes, PTs appreciate towards par and reach par as maturity is reached.
Further, because a YT represents the predicted future yield, the discount on a PT is inversely proportional to the cost of an YT.
At maturity, PTs begin to appreciate above par, accruing the yield generated on a given money-market (e.g. Compound) until redeemed.