Author: Room Temperature Coffee
Investment Summary
In the DeFi ecosystem, since the returns provided by most lending platforms and yield aggregators are usually floating, DeFi users face the risk of market fluctuations while seeking to maximize their benefits. Therefore, the introduction of interest rate derivatives in this field can not only help users effectively control risks, but will also be an important part of promoting the further prosperity and development of the DeFi market.
Pendle is based in the yield tokenization market. After the interest-bearing assets are locked up for a period of time, they are split into principal tokens PT (principle token) and yield tokens YT (yield token). While satisfying users' low-risk liquidity management needs, it also provides a tool for earning high returns for some traders who can keenly grasp yield fluctuations.
In terms of team and funding, the Pendle team is strong and has received investment from institutions such as Binance Labs and obtained sufficient funding. The team is recruiting talents, expanding business, and continuing to operate in a bear market environment.
In terms of technology, the rebuilt AMM significantly improves transaction efficiency by drawing on the AMM model proposed by Notional Finance.
The first is centralized liquidity, that is, liquidity providers only need to provide one token (PT or YT) instead of providing a pairing of two tokens;
The second is a dual fee structure, where liquidity providers can benefit from both transaction fees and interest income;
The third is the negligible impermanent loss (IL), that is, since there is a fixed exchange ratio between PT and YT, liquidity providers will not lose their principal due to price fluctuations.
The main risks include: contractual risk, strategic risk, educational risk and market risk.
In response to contract risks, Pendle has conducted multiple security audits, and its smart contracts have been inspected and verified by several well-known auditing agencies, such as Ackee Blockchain, Dedaub, Dingbats, cmichel, WatchPug, lleastwood, etc. In addition, Pendle also has a Bug Bounty program to encourage community members to discover and report any potential vulnerabilities or problems.
Regarding educational risks, Pendle has designed an educational interface to guide users, reducing the learning cost for users who are not familiar with the trading mechanism, and also opened an Earn storage page that is friendly to ordinary users.
In summary, Pendle has great development potential, but we need to pay attention to the following points:
1. The security and stability of Pendle’s online products are of utmost importance. If the protocol security issues behind the underlying assets are serious, then the contract security issues will have a great impact on Pendle.
2. Whether there are strong competitive competitors in the market is also a point that must be paid attention to.
1. Basic Information
1.1 Project Introduction
Pendle is a permissionless yield trading protocol that allows users to execute various yield management strategies.
In June 2021, the Pendle mainnet was launched on Ethereum. After the iterations of V1 and V2, Pendle has now become the top protocol in the LSDFi market. Since 2023, the amount of locked funds of Pendle has increased from 16M USD to 145M USD now (2023/9/15), an increase of nearly ten times, and because its tokens were listed on Binance, it has received a lot of attention.
1.2 Basic Information
2. Project details
2.1 Team
2.1.1 Overall situation
According to LinkedIn data, the Pendle team has a total of 15 employees, mainly engineers and BD personnel.
2.1.2 Founder
TN Lee is the founder of Pendle. Before founding Pendle, he founded the data analysis company DSR, and entered the blockchain industry in 2017 to become a member of the KyberNetwork founding team, responsible for market and business development. In 2019, he served as a consultant for RockMiner. In the same year, TN Lee founded Pendle and Dana Labs, a research and development company focusing on FPGA.
2.1.3 Core members
l Long Vuong Hoang: Head of smart contract development at Pendle, graduated from the National University of Singapore. Prior to this, he worked as an intern software development engineer at Jump Trading.
l Jeffrey Soong: Head of front-end development. Prior to this, Jeffrey worked as an engineer in several Internet companies.
2.2 Financing
2.3 Products
2.3.1 Account Panel
Pendle has two different interfaces, a simple Earn interface and a professional Trade interface.
The Earn interface will be for users who don’t know much about derivatives but want a fixed interest rate. This is achieved by purchasing a principal token, which is structured like a zero-coupon bond.
This means that users buy at a discount and can then redeem the underlying asset for full value upon maturity.
The Trade UI is more for experienced users and this is where YT and PT trading can take place.
If a user believes that the stETH APY will exceed 5% or 10% within a year, the user can purchase YT and hold it until maturity to realize the gains.
This is much more capital efficient than purchasing stETH and realizing gains before maturity.
Conversely, if a user believes that stETH’s APY will drop, they can sell their YT tokens and convert them into cash.
Essentially, it provides users with more ways to express their opinions, and also has more possibilities and combinations in strategy.
In order to better guide users’ transactions, Pendle provides two indicators on the right side of the figure: Underlying APY and Implied APY to guide users’ transactions.
l Underlying APY: The underlying annualized rate of return, or "underlying APY" for short, represents the 7-day moving average rate of return of the underlying asset. This method can more accurately indicate the underlying rate of return over a period of time, helping traders better assess the average underlying APY in the future.
l Implied APY: Implied APY, or "implied APY" for short, is the market's consensus on the future APY of an asset. This value is calculated based on the YT and PT price ratios, as shown below.
2.3.2 Trading Mechanism
Pendle's income tokenization business, in simple terms, is to split interest-bearing tokens into two parts: capital and income.
Taking DAI as an example, when a user deposits 100 DAI into Pendle, Pendle will first deposit the DAI into Compound and turn it into 100 CDAI.
Then Pendle will package the 100 cDA into a standardized yield token sy-cDAI (Standardized Yield, abbreviated as sy), and then split it into 100 principal tokens (principle token, abbreviated as PT) PT-CDAI and 100 yield tokens (yield token, abbreviated as YT) YT-CDAl.
Among them, each principal token PT-CDAI can be exchanged for one DAI after maturity: each YT-DAI can be exchanged for CDAI income during the holding period.
We can think of the principal token PT as a zero-coupon bond. The closer to the maturity date, the closer the price of PT is to the face value; the yield token YT will receive any income during the holding period. For example, YT-cDAI has lending income during the holding period, and also has the COMP incentive provided by Compound.
If a user wants to buy YT, the transaction process is as follows
1. The buyer sends 1 SY to the trading contract, hoping to buy YT;
2. The trading contract will extract N SY from the pool;
3. Split N SY into N PT and N YT;
4. Send N YT to the buyer;
5. PT is sent back to the pool.
If a user wants to sell YT, follow these steps:
1. The seller sends N YT to the trading contract, hoping to sell YT;
2. The contract will borrow N PT from the pool;
3. The contract combines N YT and N PT into N SY;
4. A portion of SY will be converted into PT and sent to the contract to repay the PT borrowed in step (2);
5. The remaining SY will be sent to the seller.
The AMM mechanism of Pendle V2 draws on the AMM model of another fixed-income project, Notional Finance. Compared with V1, the updated AMM model has higher capital efficiency and lower impermanent loss for users under the same liquidity conditions. (The red curve in the figure below is the model of Notional Finance; the black curve is the AMM model in Pendle V1; the blue curve is the AMM model of other fixed-income projects, such as Element Finance and Sense Finance).
Summary: Based on the above mechanism, Pendle is mainly suitable for the following types of investment groups:
l Low-risk investors: can purchase principle tokens (PT) to earn fixed income. PT is similar to a zero-coupon bond, which means that no interest is paid during the holding period and the bond is sold at a discount. As the maturity date approaches, the price rises and the par value is paid after maturity.
l Interest rate traders: can buy yield tokens (YT) and earn high returns when the yield rises as expected;
Liquidity provider: If the expected rate of return does not fluctuate too much, you can choose to provide liquidity and earn transaction fees, underlying asset returns and incentives;
l Arbitrageurs: When the yields do not match, or the changes in the underlying assets have not yet been transmitted to the pendle, arbitrage can be carried out by buying different asset categories.
3. Development
3.1 History
3.2 Current situation
Pendle's current TVL is about $148 million, of which Avalanche's business has been suspended, and there are some unexpired assets left for the time being, with a TVL of $1.2 million, while Optimism has a TVL of $1.6 million due to its short launch time. There is $88.65 million of TVL on Ethereum, about $44.81 million of TVL on Arbitrum, and $11.32 million of TVL on BSC.
Currently, the fixed income market demand for LSD and LSD LP tokens is relatively strong, driving the increase in the consolidated TVL.
The demand for GLP and DAI is relatively clear. Since the establishment of the pool, there has been a TVL of about 30 million US dollars. On the one hand, it is because Pendle has given token incentives, and on the other hand, there is a stronger demand for speculation and risk hedging in the market.
3.3 Future
Pendle officials have not yet given a clear roadmap. The following development plan is summarized from AYLO’s interview with the founder.
Whether it is institutional or retail, target a larger user base and convert them into more mature users. To achieve this, you need to do the following:
l The first is integration, we need to integrate with other protocols to increase community influence and provide better rates for its users.
l The second is to simplify the product. Because the entry barrier of the product is still relatively high, I think we need to continue to improve in terms of UI UX.
l The third point is one I feel strongly about, which is allowing assets to be listed on the protocol without permission.
The fourth aspect is the expansion of token utility. How can we get more users to adopt PT and YT? This is the key to our increasing adoption rate.
4. Economic Model
4.1 Token Allocation
$pendle holders can obtain vependle through staking, thereby participating in voting and governance while earning protocol income.
The Pendle Protocol has two revenue streams:
l Transaction fees: Fees generated by all transactions on Pendle AMM.
l YT Fee: Pendle charges a 3% fee on all income generated by all YTs and the income from PTs that expire but are not redeemed.
Pendle distributes all YT fee income to all vePENDLE holders, while transaction fee income is distributed to the vePENDLE voters of the corresponding pool (for example, vePENDLE holders who vote for "Pool X" will receive transaction fee income from "Pool X").
Currently, the Pendle protocol distributes all protocol revenue to vePENDLE holders, and the Pendle treasury does not receive any distribution.
In the future, a portion of the protocol revenue may be allocated to the Pendle treasury.
4.2 Token Unlock
There is no upper limit on the supply of PENDLE tokens, and the release is divided into 3 stages:
l Initial 26 weeks: 1.2 million PENDLE will be released every week;
l Week 27 to Week 260: weekly release decreases by 1%;
l Starting from week 261: the annual inflation rate will be 2% in the future to incentivize users.
4.3 Coin holdings
According to data from Etherscan, as of September 20, 2023, $pendle has a total of 5,442 addresses holding the currency, of which the top 100 addresses hold 90.76% of the holdings, and the top 10 addresses hold 61.92%.
Among the top 10 addresses, 8 are exchanges/contracts/staking addresses, accounting for 57.54%. Excluding this part, the top 100 accounts for 33.22%.
Therefore, the coin holding addresses of Pendle are relatively scattered.
4. Token value capture
In version V2, Pendle introduced the ve governance model, which reduced the token supply and increased the stability of the token and the overall strength of the protocol.
Currently, the shortest lock-up period for users is one week, and the longest is two years. The value of vependle is proportional to the lock-up period, and each wallet can only bind one vePENDLE expiration date. As time goes by, the value of vependle gradually decreases until the lock-up period ends, and the pendle will be unlocked.
Value Capture:
l vePENDLE holders who vote will receive 80% of the transaction fees of their voting pool (proportionally distributed among all voters of that pool). vePENDLE holders can vote and guide the distribution of additional rewards to different pools, effectively incentivizing different liquidity pools. At the beginning of each epoch, that is, every Thursday at 00:00 UTC, a snapshot of the voting results will be taken, and the incentive distribution ratio of each pool will be adjusted accordingly.
l vePendle will receive 3% of YT's revenue
Taking Ethereum as an example, most of the pools are ETH staking derivatives with a TVL of $90m. Assuming that the APY provided by these assets is 5%, vePendle holders can be allocated 9000*5%*3%=135,000 USD. The calculation method is the same for other chains, but the APY of staking derivatives on different chains is different.
vePENDLE holders can allocate part of the income of matured PT that has not been redeemed by the holders in proportion
For example, an expired PT-aUSDC is equivalent to aUSDC. If the holder does not cash out, all of its earnings will be converted into stablecoins and collected by the protocol as protocol income and distributed to vePENDLE holders. Regardless of where vePENDLE is stored, all of these rewards will be converted into ETH and distributed regularly by a distribution contract.
5. Competition
5.1 Industry Overview
With the booming development of the DeFi industry, interest rate derivatives are rapidly becoming a hot topic in the industry. This type of financial instrument is mainly designed based on the interest rate of crypto assets, and its purpose is to meet the needs of DeFi users for a combination of returns.
Interest rate derivatives in traditional financial markets, such as interest rate swaps and interest rate futures, have been used to avoid the risks brought by interest rate fluctuations.
In the DeFi ecosystem, since the returns provided by most lending platforms and yield aggregators are usually floating, DeFi users face the risk of market fluctuations while seeking to maximize their benefits. Therefore, the introduction of interest rate derivatives in this field can not only help users effectively control risks, but also will be an important part of promoting the further prosperity and development of the DeFi market.
In addition, as institutional funds pour into the DeFi market, the demand for stable and predictable returns is gradually increasing, which also drives the continuous innovation of fixed-rate and related derivatives.
5.2 Competitive Product Selection
In the interest rate derivatives track, Pendle's competitors (such as Voltz Protocol, Sense Finance, Yield Protocol, etc.) do not have a clear advantage. Most of them support a small number of interest rate derivatives and do not run on multiple chains. This brings great inconvenience to users and reduces the optional trading combinations. The TVL data also confirms that these projects are not recognized by users.
In contrast, Pendle has the advantages of separating PT from YT, highly efficient AMM model, supporting various interest rate derivatives transactions, and meeting the interest rate trading needs of multi-chain users. The rebound of the crypto market bear market accompanied by TVL has exceeded the previous bull market high in one fell swoop. This also shows that the demand for fixed-rate products in the crypto market is growing.
6. Risks
l Contract risk: Hacker attacks have never stopped, and the types of stolen projects are not limited to decentralized exchanges and lending protocols. If such an incident occurs, it will have a significant impact on the normal operation of the project and the capture of token value. This risk is not only on Pendle itself. Since Pendle's underlying assets come from other projects, if other projects have contract risks, Pendle will also be implicated, causing Pendle's business and operations to shrink.
l Strategic risk: It is critical to choose the right underlying assets. If you do not choose the right assets and the public chain where the assets are located, you may be left behind by your competitors in the next stage of competition. In the V1 version, choosing to deploy on Avalanche currently seems to be a strategic mistake. Its Avalanche business has been declining after a short rise. The project team did not think clearly about what kind of underlying assets should be chosen at the time, and did not anticipate the cruelty of public chain competition, which led to the failure of the plan to deploy Avalanche in the V1 version.
l Educational risk: The interest rate trading market is a relatively new and complex concept, which requires more time and effort for users to understand and use.
l Market risk: The price of some underlying assets, such as GLP, is not anchored to the US dollar or public chain tokens, is in a relatively floating state, and is not very convenient for hedging. This is not friendly to U-based investors. If the market falls sharply during the operation of the project, causing the price of GLP denominated in US dollars to fall, investors in YT, in particular, may suffer large losses, which may cause users to lose to other relatively safe projects.
References
https://coinmarketcap.com/currencies/pendle/
https://www.linkedin.com/company/pendlefinance/people/
https://defillama.com/protocol/pendle
https://research.web3caff.com/zh/archives/10929?ref=778
https://multicoin.capital/zh/2021/10/06/exploring-the-opportunity-for-defi-interest-rate-markets/
https://www.rootdata.com/zh/Projects/detail/Pendle?k=ODc0
https://docs.pendle.finance/cn/Introduction
https://handbook.pendle.finance/?utm_source=app&utm_medium=app
https://raw.githubusercontent.com/pendle-finance/pendle-v2-resources/main/whitepapers/V2_AMM.pdf