Pendle: Yield Trading for LSD and LP Tokens | TKX Weekly

6 min readMar 28, 2023

As the Shanghai update approaches, the DeFi community is witnessing a growing interest in liquidity staking derivatives (LSD). Many users are exploring protocols that enable them to optimize their yields using LSD-based strategies. Pendle, a notable protocol, has piqued the interest of many in the space. It recently reached an impressive milestone, with its total value locked (TVL) hitting an all-time high of $40 million — surpassing its previous peak from over a year ago. In this article, we’ll explore the distinctive features and benefits of the Pendle Protocol in depth.

Intro

Pendle is a DeFi protocol that empowers investors to access an asset’s future yield via a tokenized yield trading mechanism. What sets Pendle apart from other yield protocols is its unique AMM feature and innovative yield components. Built on the Ethereum blockchain, Pendle enables users to employ various yield strategies, such as long yield, discounted long assets, and fixed yield. Users can separate their assets into principal and yield tokens, allowing for increased flexibility and simpler management. The platform also supports Arbitrum and offers an array of liquidity pools for enhanced yield optimization.

Pendle has recently launched its V2. This update introduces an improved AMM that facilitates fixed-rate trading, optimizes liquidity provisions, and presents greater profit opportunities.

How Pendle Works

Upon depositing their yield-generating assets into a Pendle account, the platform wraps the assets into standardized yield tokens (SY). The SY then mints a principal token (PT), representing the underlying asset, and a yield token (YT), representing the token holder’s claim on the asset’s future yield. It is crucial to remember that both PTs and YTs have maturity dates, and users can claim their associated assets when these dates arrive. The following formulas always hold true in Pendle’s Automated Market Maker (AMM):

Principal Token (PT)

PT works like a zero-coupon bond, meaning it does not include the yield component. People can buy a PT at a discounted price and redeem a full underlying asset for their PT upon maturity.

For example:

There is a stETH pool with a maturity period of 1 year. The current price for 1 PT stETH is 0.94 stETH, with an implied APY of 6.4%. This means that people can purchase 1 PT stETH by paying 0.94 stETH, and then redeem 1 stETH after the maturity period. The implied APY determines the price of PT. PT can be a useful tool for locking in yield if you expect the yield to decrease in the future. In other words, buying PT is a way to short the yield.

Yield Token (YT)

Yield Tokens (YT) are traded on the Pendle AMM in the same pool as Principal Tokens (PT). It gives you the right to receive the yield on the underlying asset until maturity.

For example:

There is a stETH pool with a maturity period of 1 year. The current price for 1 YT stETH is 0.04 stETH, with an implied APY of 4.2%. This means that people can purchase 1 YT stETH for 0.04 stETH and have the right to collect stETH yield for the next year. The implied APY of 4.2% is the price that the market is pricing the average future APY of stETH to be for the next year. In other words, it’s the cost of buying 1 YT.

If someone chooses to buy 100 YT stETH (4 stETH), they will receive 5 stETH worth of yield, netting a 25% APY, assuming that the average future APY remains at the current underlying APY. However, if the average APY increases to 5.5% within the next year, they will receive 5.5 stETH worth of yield, netting a 37.5% APY.

YT is a tool to long the yield if you expect the yield to increase in the future. If the average future APY is greater than the implied yield, the trade is profitable; vice versa.

AMM

Pendle’s V2 AMM is designed to trade yield and is optimized to account for the behaviors of PT and YT tokens. The AMM curve adjusts to reflect the yield accrued over time and narrows the PT’s price range as it approaches maturity, which increases capital efficiency by concentrating liquidity into a more meaningful range.

Additionally, Pendle has implemented a AMM that enables PT and YT swaps using a single pool of liquidity. This allows PT to be directly traded with SY, while YT trades can be conducted through flash swaps.

Trading Principal Token (PT)

In Pendle V2, liquidity pools are established as PT/SY pairs, such as PT-GLP/SY-GLP. Swapping PT is simple, involving a trade between the two assets within the pool. In contrast, trading YT is facilitated via flash swaps within the same pool.

Trading Yield Token (YT)

When buying YT on Pendle, the buyer sends SY into the swap contract. The contract then withdraws more SY from the pool and mints PTs and YTs from all of the SY. The YTs are then sent to the buyer, while the PTs are sold for SY to return the amount from withdraw.

When a seller wants to sell their YT tokens on Pendle, they can send their YT tokens into the swap contract. The contract then borrows an equivalent amount of PT tokens from the PT/SY liquidity pool. The YT and PT tokens are then used to redeem SY tokens from the pool. A portion of the SY tokens is then swapped back into PT tokens to return the amount borrowed. Finally, the remaining SY tokens are sent to the seller’s address.

Closing Thoughts

In the traditional finance world, the interest rate swap market is the largest segment in derivatives. However, the DeFi market is still much smaller than traditional finance, and it is uncertain whether the DeFi interest rate swap market can grow to a size that can compete with the traditional finance interest rate swap market, at least in the near future.

That being said, Pendle is a project worth keeping an eye on, especially in the context of the narratives of LSD and real yield. As GMX’s real yield has been proven to be sustainable, protocols like Pendle that can provide real value to DeFi players have the potential for success.

Reference

https://docs.pendle.finance/Home
https://app.pendle.finance/pro/learn
https://twitter.com/NintendoDoomed/status/1637475974454431747?s=20
https://twitter.com/2lambro/status/1613711770056810499
https://defillama.com/protocol/pendle

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Note: TKX Capital do not offer any financial advice for retail investors and we have no affiliation with projects in this research.