DeFi vaults are the onchain equivalent of a professional managed account. Instead of needing to jump between protocols and sign many transactions yourself, you make a single deposit into a smart-contract vault and simply let it work for you. Under the hood, the contract pools your funds with others and moves them through multiple strategies while you hold a token representing your claim on that total pool.

Here is what truly happens behind the scenes.

From deposit to tokenisation

When you deposit assets like ETH or stablecoins, the vault doesn't just stick your name on a pile of crypto. Instead, the smart contract immediately issues you a receipt token that represents a share of the total pool. This standard approach ensures that deposits and withdrawals work consistently across different protocols.

The receipt token is your verifiable proof of ownership. Because it is a tokenized claim, you can transfer it or even use it as collateral in other protocols. As rewards accumulate in the pool, the value of each receipt token increases relative to the underlying asset.

Strategy execution and capital routing

The true value a vault delivers comes from the strategies it executes. A controller module monitors the markets and routes capital from the shared pool into various DeFi protocols.

The sophistication varies:

• Basic Strategies might simply stake ETH to earn validator rewards or supply stablecoins to a lending market.

• Complex Strategies can involve multi-step trades, like looping collateral and debt, or engaging in airdrop campaigns.

For example, platforms like Gain vaults manage this complexity by pooling assets and having professional curators allocate it across multiple protocols, like Aave or Compound. They move funds when rewards change and constantly rebalance to protect the portfolio.

Reward generation and distribution

Every strategy produces rewards—whether it's trading fees from liquidity pools, interest from lending, or incentive tokens from staking.

The vault’s execution module automatically harvests these rewards. Critically, instead of sending them to your wallet (which would cost gas fees every time), the vault automatically reinvests them to compound the position. As this compounding happens, the value of your receipt token increases. When you withdraw, you redeem your receipt tokens for your share of the base asset plus all the accrued rewards, minus any performance fees.

Ongoing risk management

Vaults are not entirely risk-free, so they are engineered with constant risk management. Strategy contracts embed safeguards such as automated stop-loss triggers, leverage caps, and value-at-risk limits. Curators may also include utilization caps and circuit breakers to prevent widespread damage if one protocol fails.

This active management works: the Gain's High Gain vault illustrated this by quickly reducing exposure when a lending protocol later faced challenges. However, depositors still bear the risk of code bugs, oracle manipulation, and volatile market prices.

What “earning” really means

Vaults turn complex DeFi operations into an easy-to-use "earn" product. When you earn 12-18% rewards from High Gain, those rewards are actually produced by lending fees paid by borrowers, staking incentives, and trading fees. The strategy manager’s job is to allocate your deposit across these sources with a sharp eye on risk.

Vaults like Gain show how DeFi can abstract away operational complexity while keeping control and transparency with the user. You delegate the operational work to automated strategies, and in return for that convenience, you pay fees and trust the risk management.

Disclaimer: This is not financial advice. Always DYOR and understand the risks involved before depositing into any DeFi protocol.