> For the complete documentation index, see [llms.txt](https://docs.trilobyte.finance/llms.txt). Markdown versions of documentation pages are available by appending `.md` to page URLs; this page is available as [Markdown](https://docs.trilobyte.finance/overview/tranches-and-the-waterfall.md).

# Tranches and the Waterfall

Every Trilobyte vault splits its investors into two tranches — **senior** and **junior** — and pays every repayment through a strict, ordered waterfall. This page explains why, in plain language, using the protocol's own worked example.

## Why two tranches?

A single pool of investors sharing every loss equally is fragile: a handful of bad loans can wipe out everyone at once. Trilobyte instead borrows a structure from traditional securitisation (and from DeFi lenders like Goldfinch and Maple): split investor capital into two layers with different risk and reward.

* **Junior** — the first capital to absorb a loss, and the last to get paid. In exchange, it earns a **spread** on top of the loan's own interest rate.
* **Senior** — protected by the junior layer beneath it. It gets paid first every period, and only loses money once junior is completely wiped out. In exchange, it earns a lower, steadier yield.

The pool manager's own collateral — their skin in the game — is the anchor of the junior tranche. Junior investors can join alongside it. Senior is open to a broader base of investors (including wallet users and external liquidity providers) once the junior cushion is locked in.

## The capital stack

The size of the junior cushion is set by the vault's **leverage ratio** — how large senior capital may be as a multiple of junior. A 4× leverage ratio means senior can be up to four times junior, i.e. junior makes up 20% of the total; a 3× ratio means junior makes up 25%. Governance sets separate leverage caps for uncollateralized loans and for loans where the borrower has also pledged a real-world asset — a pledge lets the junior cushion run thinner, because the pledge is recovered ahead of the residual split.

```mermaid
flowchart TB
    subgraph Stack["Vault capital stack — worked example: 100,000 USDC loan, 4x leverage"]
        direction TB
        Senior["SENIOR — 80,000 USDC\npaid first, lower yield\nwallet users, external investors"]
        Junior["JUNIOR — 20,000 USDC\nfirst loss, earns the spread\nmanager collateral + junior investors"]
        Pledge["Borrower pledge (optional)\nseized first on default, ahead of both tranches"]
    end
    Senior -->|protected by| Junior
    Junior -->|backstopped by, if present| Pledge
```

Junior must be locked (`lock_junior`) before any senior deposit is accepted — see [RaisingFunds](/protocol-mechanics/vault-lifecycle/raising-funds.md).

## The six-bucket waterfall

Every repayment — and every default recovery — is allocated in the same strict order. Nothing moves to the next bucket until the one before it is fully paid; an underpaid bucket carries forward as **arrears**, which must be cleared before any new dues are paid.

```mermaid
flowchart TD
    P["Borrower pays 9,026 USDC\n(month 1 installment)"] --> B1
    B1["1 · Reserve fee → treasury\n125 USDC (10% of interest)"] --> B2
    B2["2 · Senior interest\n700 USDC"] --> B3
    B3["3 · Senior principal\n6,221 USDC"] --> B4
    B4["4 · Junior interest\n425 USDC"] --> B5
    B5["5 · Junior principal\n1,555 USDC"] --> B6
    B6["6 · Residual → borrower cash pool\n0 USDC — nothing left this period"]
```

*Worked example: 100,000 USDC loan, 15% annual rate, 4× leverage, 20% junior spread, 10% protocol reserve fee. Month one's installment is 9,026 USDC (1,250 interest + 7,776 principal). See* [*Payments & the Waterfall*](/protocol-mechanics/payments-and-emi.md) *for the exact math.*

### What a short payment looks like

If the borrower can only pay 5,000 of the 9,026 owed, the waterfall still fills in order: reserve fee (125), senior interest (700), then as much of senior principal as remains (4,175). **Junior and the borrower get nothing** — junior is paid last, and the borrower's residual only exists after both tranches are served. The 4,026 USDC shortfall carries forward as arrears, ahead of next period's dues.

## What happens on default

If a loan defaults, both collateral sources — any borrower pledge and the manager's collateral — join the funds already in the vault into one recovery pool. That pool then pays out in the same seniority order: senior principal, senior's unpaid interest, junior principal, junior's unpaid interest, and only then any residual to the manager and the borrower. See [Default & Risk Management](/protocol-mechanics/default-and-risk-management.md) for the full mechanics.

## Effective yields, worked example

| Party    | Capital | Nominal rate | Effective yield  | Why                                                                               |
| -------- | ------- | ------------ | ---------------- | --------------------------------------------------------------------------------- |
| Senior   | 80,000  | 15.0%        | 10.5%            | Gives up 10% to the protocol reserve and 20% to junior. Paid first.               |
| Junior   | 20,000  | 15.0%        | 25.5%            | Keeps its own interest plus the spread taken from senior. Paid last, loses first. |
| Protocol | —       | —            | 1.5% of the loan | 10% of all interest, senior-most in the waterfall.                                |
| Borrower | 100,000 | 15.0%        | —                | Pays 9,026/month. Keeps only what's left after debt service.                      |

These parameters — the reserve fee, the junior spread, and the leverage cap — are all governed settings (see [Fees](/protocol-mechanics/fees.md) and [Covenants, Exposure and Compliance](/protocol-mechanics/covenants-exposure-and-compliance.md)), so the protocol can tune them per market without a contract upgrade.

*As of September 2026.*