Investment Logic

A complete income strategy toolkit

In traditional financial markets, the daily trading volume of interest rate derivatives reaches trillions, and market participants can use this financial product to speculate or hedge against fluctuations in interest rates. As decentralized finance (DeFi) continues to mature, the opportunities for such returns will gradually increase. Whether providing liquidity for trading on the GMX/Gains Network or participating in liquidity staking like Lido, investors looking for yield have many options. But how do users trade yield in today’s market? For example, what if I believe that the yield currently offered by GLP is undervalued and expected to rise in the coming days? What if I believe that the current Stargate yield does not accurately reflect stablecoin trading volume and could drop quickly? What if I just want to remain market neutral and earn extra income?

With short-term yield speculation opportunities emerging like Ethereum’s Shapella upgrade, Vu Gaba Vineb succinctly outlines the various possibilities for how ETH and LSD yields could change — whether you think it will go up, down, or sideways, Pendle has a strategy for you to profit.

Pendle provides users with a full set of tools to enjoy fixed income through discounted asset purchases, speculate on income through YT (more on this below), or participate in their pools to earn additional income through exchange fees and rewards. Protocols like Equilibria are already using Pendle to build more yield enhancement strategies, and we foresee more protocols will develop products based on Pendle in the future. For individual investors, Pendle simplifies the user interface to optimize the user experience and facilitate users to participate in various yield strategies.

We are excited about the new paradigm that Pendle opens up for yield traders as they can now manage the risk of their holdings based on market volatility.

Product Highlights

Founded in 2021, Pendle Finance is a decentralized finance (DeFi) protocol where users can purchase assets at a discount, participate in various yield strategies, or earn income by providing liquidity to the fund pool. Currently, Pendle has been deployed on Ethereum and Arbitrum. TVL has grown from $7.8 million in December 2022 to $60.5 million today, an increase of nearly 775% in just five months.

SY, PT, and YT

Pendle is a yield trading protocol where we can mark the yield of interest-bearing assets (such as GLP, stETH, aUSDC, etc.) as YT and PT, where holding YT will earn yield and PT represents the principal. Since the yield portion of YT is stripped off, users will be able to buy PT at a discount. For example, buying PT-GLP is equivalent to getting GLP at a discount, and 1 PT-GLP can be exchanged for 1 GLP at maturity. How is the PT-GLP discount determined? Fundamentally, the discount rate is determined by the market demand for PT-GLP. If there is a lot of demand for PT-GLP, the discount will naturally be lower, and vice versa if the demand is smaller.

What is SY? It is a token standard that implements a standardized API for wrapping interest-bearing assets in smart contracts.

Afterwards, the principal and yield of these interest-bearing assets can be stripped into PT and YT tokens. Looking at the chart below, SY refers to the underlying yield asset (in this case aUSDC), which is then split into PT-aUSDC and YT-aUSDC. This provides users with a large number of strategies.

For users who wish to avoid volatility, they can purchase PT tokens now at a discounted price and hold until maturity. For example, if PT-GLP is trading at a 22.5% discount, this means that if you buy 1 PT-GLP today, the trader is essentially locking in a 22.5% gain and receiving a fixed return. If the trader also believes that future returns will be less than 22.5%, this gives you the opportunity to sell PT-GLP at a profitable price, or earn a higher return than just holding GLP. On the other hand, users looking to speculate on future earnings can purchase YT tokens to increase their exposure to yields. In this case, you might think that the 22.5% yield is undervalued, then you could buy 1 YT-GLP today and sell it when the yield rises above 22.5%, or earn additional yield before expiration. In summary, buying PT is equivalent to shorting yield, while buying YT is equivalent to going long yield.

LP Pool

For users seeking a more passive strategy, liquidity pools on Pendle are a simple and easy way to go. The pool annualized yield (APY) is composed of four sources of income: (a) a fixed yield from holding PT to maturity; (b) underlying token protocol rewards from yielding assets (such as GLP); © fees from SY, PT, and YT transactions; (d) Pendle rewards; additional income from vePendle by staking Pendle. As you can see, these returns are very attractive, and due to the high correlation between pool assets, coupled with Pendle's unique automated market maker (AMM) design, users face almost no impermanent loss. Over time, we should see an increase in interest-bearing assets.

Unique AMM design

In Pendle v2, the main innovation lies in the AMM trading platform designed and built for yield trading. Since the assets in the pool are highly correlated, this will reduce the impermanent loss (IL) caused by volatility. More importantly, if the assets stay in the pool until maturity, the impermanent loss will be 0. Because at maturity, the PT in the pool will be equal to the underlying asset. In short, users will be able to trade between SY, PT, and YT with almost no impermanent loss.

Another feature of Pendle v2 AMM is higher capital efficiency. With the introduction of flash exchange, users can now easily purchase YT on a simple user interface and start participating in various yield strategies. This means that LPs can earn fees from PT and YT exchange in a single liquidity provider, while traders can enjoy greater liquidity and thus reduce slippage.

With the emergence of various interest-bearing assets, whether generated through lending platforms (such as Aave, Compound, etc.) or through staking on the LSD platform, Pendle has a huge market to expand.

vePENDLE

Pendle borrows from the veCurve and Solidly models, where existing token holders can stake $Pendle to obtain $vePendle, thereby reducing the circulating supply of $Pendle on the market. A major attraction of $vePendle is to earn a portion of the protocol revenue. Today, there are two sources of protocol revenue in Pendle V2:

a) YT Fee: Pendle takes 3% of all revenue generated by YT

b) Swap Fee: Pendle extracts 0.1% of the transaction value, which decreases as the expiration time decreases, and vice versa. 20% of the above fees belongs to the liquidity provider, and the rest will be distributed to $vePendle holders. In addition, the expired PT income will also be distributed proportionally

c) $vePendle token holders can also re-invest their $Pendle rewards into liquidity pools weekly based on their voting weight, earning increased rewards (up to 2.5x) in any Pendle pool they provide liquidity to

d) $vePendle decreases linearly over 2 years, after which $Pendle will be released. Therefore, users who wish to maintain their voting weight/$vePendle token value will need to extend their stake duration or stake amount

Factors driving recent growth: LSDs will explode

After the Shapella upgrade, users will be able to withdraw Ethereum. In this way, liquid collateralized derivatives will be able to better maintain their anchor prices, making them better collateral for borrowing, which will increase the utilization of DeFi protocols. As of April 6, 2023, data from Deflama showed that the TVL of the LSD industry has grown to US$16.6 billion, ranking second among all DeFi sub-industries.

In a thriving ecosystem, Pendle is positioned as the infrastructure to support these LSD assets. Currently, Pendle has shown traction and has received support from well-known projects like Lido, Frax, Rocketpool, Aura, GMX, and Stargate. We believe that TVL will continue to climb as the protocol gains more partners and other projects in the ecosystem begin to appreciate Pendle's excellent design in liquidity provision. Rather than trying to pick the top LSD projects, we prefer Pendle's unique positioning as a supporting protocol. Users who want to hedge or improve their LSDs more actively can look at Pendle's discounted assets.

Gap in fixed income products in the market

Fixed-income products are commonplace in traditional finance, but are relatively rare in the cryptocurrency space. Yield volatility has always been one of the themes of cryptocurrency. For example, the yield of stETH has generally fluctuated between 4–5% in the past 30 days, with a peak of 7.1% and even 10.2% in November 2022.

Fluctuating yields bring uncertainty, especially for investors holding leveraged positions. This requires them to manage returns more actively, and investors need to weigh the opportunity costs and risks of their positions relative to other DeFi projects. Therefore, for investors, fixed yields provide a more efficient and worry-free strategy.

As we can see, users can get gDAI and USDT at discounts of 9.09% and 5.12% respectively, just by holding them to maturity, which is much higher than today’s traditional fixed income products (e.g. T-bills at around 4.5%).

in conclusion

In summary, we believe that Pendle now provides users with a variety of tools to manage various income strategies. The fixed income and interest rate derivatives market in traditional finance is huge, and we believe that Pendle will be able to attract more institutional capital attention and favor over time.

Pendle uses a standardized form to tokenize interest-bearing assets, which makes it easier to integrate other interest-bearing assets in the future and unlocks more composability for other DeFi protocols, allowing them to integrate Pendle or build more and richer applications on top of Pendle.

Disclaimer: Bixin Ventures is an investor in Pendle and all content mentioned is for educational purposes only and should not be construed as financial advice.

Article contributors: Evan Gu, Henry Ang, Mustafa Yilham, Allen Zhao, Jermaine Wong