1. Project Introduction
Pendle Finance is a DeFi yield trading protocol deployed on Ethereum and Arbitrum. Yield trading may be difficult to understand, but in short, Pendle is a DeFi protocol that allows users to achieve the following:
Buy assets at a discount Long and short yields Low-risk fixed income
Pendle Finance achieves the above functions by splitting the interest-bearing assets on DeFi into PT (principal token) and YT (yield token)
2. Implementation Principle
The Pendle project team has written an easy-to-understand tutorial to explain PT, YT and the significance of their existence. The tutorial is very well written. If you have patience, you can click the link to take a look: https://app.pendle.finance/pro/learn
If you are a finance major, here is a simple explanation of the principles of PT and YT: PT is approximately equal to a zero coupon bond, and YT is approximately equal to an interest swap agreement.
If you think the official tutorial is too long, you can take a look at the principles I wrote below, and try to make it understandable even if you have no basic knowledge.
Interest-earning assets:
First of all, we mentioned a concept - interest-bearing assets
All the underlying assets of the Pendle protocol are interest-bearing assets. What are interest-bearing assets? The stETH that everyone has come into contact with in the recent Shanghai upgrade, the aUSDC you get from AAVE, and the cDAI you keep in Compound are all interest-bearing assets.
For example, if you stake 1ETH on Lido and get 1stETH, and the current staking yield is 5%, then this 1stETH will become 1.05stETH after one year. In this example, your principal is 1stETH and the interest is 0.05stETH.
PT,YT:
So Pendle packages the principal 1stETH into PT and the profit 0.05stETH into YT.
Seeing this you may wonder, what is the point of doing this?
The essence of PT packaged with 1stETH principal is: if you hold this PT, you can get 1stETH after one year.
The essence of PY packaged with the future income of 0.05stETH is: if you hold this PY, you can get the income corresponding to the principal of 1stETH after one year.
The price of 1PT stETH will be lower than 1stETH, because 1PT stETH can only be obtained after one year.
So suppose you sell PT on the market, the selling price may be 0.96stETH, and the corresponding YT will be priced at 0.04stETH (PT+YT=1stETH, otherwise you can arbitrage without risk)
When you put PT YT on the market, something interesting happens.
For buyers, PT is like stETH being sold at a discount, except that they have to wait a year to get stETH.
For buyers, YT is a bet on the change in stETH yield. Under the expectation of 5% staking yield, YT is priced at 0.04stETH, but there will always be people who expect stETH staking yield to rise in the future, so they will buy YT. If the yield becomes 6%, then YT can get 0.06st ETH after one year.
actual case:
The above picture shows a PT stETH and PT stETH with an expiration date of one year. The price of PT is 0.957stETH and the price of YT is 0.043stETH. The implied APY of YT is 4.5% (implied APY is the APY data inferred from the price), which means that the market generally believes that the corresponding annualized return of YT is 4.5%. At this time, there is a user who expects the future rate of return to rise, for example, to 5.5%, so he will buy YT because he thinks YT is now undervalued. So this user's operation is long the rate of return, and the corresponding YT seller is shorting the rate of return.
III. Project Highlights
1. The positive flywheel effect of the development of the DeFi industry and the increase in the types of interest-bearing assets
Pendle is an old DeFi protocol that was launched in 2021, but it has been tepid before. TVL has been declining in 2022, but it started to grow rapidly again at the end of 2022. One of the key points is that the Shanghai upgrade has brought the LSD sector into the spotlight.
As mentioned earlier, Pendle's protocols are all based on interest-bearing assets. In 2021, when Pendle was launched, interest-bearing assets were nothing more than aToken, cToken or LP that appeared around lending protocols and DEX, and there were limited things to play with. The concept of POS pledge that appeared after Ethereum Merge made the LSD pledge doll sector more diverse and larger in terms of the types and volume of interest-bearing assets. Pendle also launched a series of income strategies related to ETH LSD in the second half of 2022, allowing its TVL to grow rapidly. The upcoming Shanghai upgrade will surely further promote its TVL growth.
2. Simple is good
Different from most complex DeFi protocols, although Pendle has innovated the gameplay of PT and YT, they do not want to make the product too complicated. After all, interest rate swaps and zero-coupon bonds are really far away from users.
To use Pendle's products, you don't even need to understand the basic principles of PT and YT. Pendle's front-end interface is as follows:
In the Simple version of the front end, users only need to know that they can purchase ETH at a discount through the protocol, and do not need to understand that the essence behind it is trading PT.
But there’s an old saying, “If you don’t know where the revenue comes from, then you are the revenue.”
So after clicking on the corresponding strategy, the FAQ is directly displayed on the right side of the interface, briefly introducing several issues that users are most concerned about.
And as I said when I introduced the principle earlier, the principle tutorial written by Pendle is rare in the cryptocurrency circle. It shows you the principle of the project like peeling silk from a cocoon, and users with basic DEFI knowledge can understand it. Pendle's principle tutorial document is the core reason why I wrote this article, because in the cryptocurrency circle, which is a big melting pot of good and bad people, reading good documents is really a pleasure.
3. Real income
In terms of token economics, Pendle refers to Curve's VE model and distributes all protocol revenue to vePendle's Holders. This means that the higher the TVL of the protocol, the more management fees are collected, and the greater the Holder's income.
IV. Conclusion
From an innovation perspective, Pendle's mechanism is not new, but the highlight of Pendle is that it packages a product with complex principles in a way that is as simple to understand and easy to operate as possible. This is something I have not seen in many DeFi protocols, especially the recent ones.
As the industry develops, the composability of DeFi protocols has spawned a variety of nesting doll products. However, no matter how good or complex a product is, it still needs people to use it. The operation interface of many DeFi protocols is confusing, and it is difficult to learn how to use them without spending a few hours in the documentation.
One of the original intentions of DeFi is to allow ordinary people to have access to finance at a low cost, but DeFi is gradually developing in the direction of complexity and high barriers to entry. (Related reading: "A Brief Analysis of Pendle Finance: 3 Times in 3 Months, How to Tell the LSD Narrative?")