What Is Pendle & How Does It Work?
Pendle Finance is an innovative Decentralized Finance (DeFi) platform whose primary function is to bring improvement to yield trading through tokenizing and trading of future yield. Pendle brings new features that address the increasing trend of yield management in DeFi. By dividing the yield-bearing assets into principal and yield tokens, Pendle enables users to hedge, lock in, or trade future yields. By understanding how it works, you can execute various yield-management strategies and earn passive income.
How Pendle Works
Understanding the concepts below will create the foundation for understanding how Pendle works.
- Yield Tokenization First, Pendle wraps yield-bearing tokens into SY(standardized yield tokens), which is a wrapped version of the underlying yield-bearing token that is compatible with the Pendle AMM (e.g. stETH → SY-stETH). SY is then split into its principal and yield components, PT (principal token) and YT (yield token) respectively. This process is called yield-tokenization, where the yield is tokenized into a pair of separate tokens.
- Pendle AMM Both PT and YT can be traded via Pendle’s AMM. Even though this is the core engine of Pendle, understanding of the AMM is not required to trade PT and YT. This separation enables the users to interact with the principal and yield tokens in an individual manner.
Here is the detailed information on how each of these tokens work:
Principal Tokens (PTs): Borrower’s ownership on the underlying Asset.
Principal Tokens (PTs) are tokens that give the holder ownership of the actual yield-bearing asset with no claim to the future yield that the asset will bring. In simpler terms, PTs provide you with the ability to redeem the underlying asset (stETH, aToken, or any other yield-bearing asset) at PT’s due date, but during the PTs holding period, it does not earn yield.
Key Points About PTs:
Ownership Only, No Yield: PTs enable the users to retain control of the principal fluctuating asset. For instance, if you deposited 1 stETH, you are going to get 1 PT-stETH in return. But holding this PT means that you get to redeem your 1 stETH at maturity, and you do not get any staking rewards or yield during this duration.
Redemption at Maturity: When the PTs get to their maturity, it is possible to exercise them where you are able to get hold of the actual asset. This means that you receive the initial deposited asset like stETH for example.
Discounted Pricing: This is mainly because PTs do not incorporate future earnings therefore indicating a relatively cheaper price than the actual value of the asset. There is a guaranteed value appreciation from the discounted pricing which constitutes the fixed yield.
Yield Tokens (YTs): Claim on Future Yield
This is referred to as the claim on future yield. Yield Tokens (YTs) is the right to receive the yield associated with the asset for a given period up to the time of maturity. These tokens let consumers gamble, protect themselves, or obtain a guaranteed yield depending on how they expect the yield will perform in the future.
Claim on Yield: With YTs, you can claim the yield or interest on the underlying asset in a given period before the tokens mature. For instance, if you hold YTs for stETH, this implies that you get the staking rewards that result from the stETH in the process.
Tradable Yield: PTs can be traded in the open market without YT being traded, the concept enables an investor to sell the future yield or buy yield of the other asset. This creates a speculation space where people can make bets as to whether they think the yield will rise or fall.
Speculation on Yield: Since yield in YTs can change based on market yields, the instruments can be used to hedge or speculate on such changes. For instance if you are expecting staking rewards of stETH to go up in the future, you will purchase YTs now to capture a piece of the higher rewards.
Expiry at Maturity: However, when the yield period is over, the YTs are no longer valid and their value declines as they approach the maturity date. At this point, holders stop earning yield, and the tokens are not useful in any other way except to be traded before they reach their maturity.
RELATIONSHIP BETWEEN PTs AND YTs
Recall that Pendle works with yield bearing assets, these are assets that bear yield or some form of income, for example a real estate property.
A real estate asset can provide income in the form of rental or outright sale. With regards to Pendle this can be seen as:
The rights to the ownership of the property. You can think of this as the Principal. Which you can buy at a discounted price than the actual property. After 1 year, the rights entitle you to redeem the property.
This is entirely different from the rights to the rental income of the property, you can think of it as the Yield, which can grant its owner the right to collect all the rental income (AKA yield) generated by the property for a certain length of time.
So a single asset is split into two and more value is generated from the asset.
Let’s look at another example, coming home to crypto land, a popular example of a yield bearing asset include staked ETH, stETH.
stETH is divided into:
Principal (Right to Principal of stETH)
Yield (Rights to stETH yield)
If the price of stETH token is 1ETH, after splitting it up you will be able to buy the Principal (Right to Principal of stETH) for 0.9ETH with a maturity of 1 year. After holding for a year you can redeem 1ETH worth of stETH. Having an extra 0.1stETH.
The yield aspect of a yield bearing token is called Yield token, you spend 0.1ETH to buy a YT-stETH with a 1 year maturity, this gives you the right to earn the yield of a staked ETH token for a year at the cost of 0.1ETH. Yield fluctuates from time to time and you can claim your yield rewards as you go as long as you have collected more than 0.1ETH in yield rewards by the end of the maturity, you made profit!
How PTs and YTs Work Together
Fixed Income vs. Variable Income: Holding PTs provide a fixed yield on the underlying asset with no fluctuation in yield, whereas holding YT provides an unpredictable yield with fluctuation in yield during and after maturity.
Discounted Entry: The PTs can be bought by investors at a cheaper price than their face value bearing in mind that the investors will be paid in full, their money and the value of the asset at the due date. At the same time, arbitrageurs may also participate to obtain yield expectations on YTs.
Key Features OF Pendle
Yield Tokenization: Pendle makes it possible to break yield generating tokens for example stETH or aTokens into pieces that can be traded, thereby affording extra versatility to manage yields.
Liquidity Provision: Users can deposit their tokens into the Pendle AMM pools and stake them to earn swap fees and rewards based on trading volume and governance.
vePENDLE And Governance.
Pendle follows a decentralized autonomous organization (DAO) structure, whereby vePENDLE token holders are entitled to vote on crucial protocol parameters like rewards and fee.
shareholders vote on key parameters such as incentives and fees where it operates. Staking PENDLE coins allows users to gain votes in direct correlation to the period of time they lock their tokens for up to two years.
Launch and Backers.
Pendle was established in June 2021 on the Ethereum blockchain. The project quickly attracted attention from leading investors like Mechanism Capital which participated in the private token sale round in April 2021 when $3.7 million was raised. Pendle has since expanded its ecosystem to other networks like Arbitrum, Optimism, and BNB Chain, demonstrating significant growth in total value locked (TVL) and trading volume. As of 2024, Pendle has processed over $18.5 billion in trading volume and holds over $6 billion in TVL.
Problem Pendle Seeks To Solve.
Regarding the deterministic and stochastic characteristics of DeFi yields, Pendle focuses on the unpredictability they harbor. Typically, DeFi services provide opportunities to generate income, but this income fluctuates quite a bit in response to market circumstances and internal processes. Pendle allows users to lock in fixed yields or hedge against volatility by buying discounted principal tokens. This brought the much-needed structure and order in the DeFi environment that was characterized by too much disorder and uncertainty.
In addition to providing a pure play yield play, Pendle also unlocks new forms of arbitrage, speculation, and risk management by decoupling yield from the underlying asset. This is so important especially for institutional investors or any players in DeFi who seek to hedge against risks related to varying rates of returns.
Conclusion
Pendle Finance is an important addition to DeFi because it offers users a way to trade future yields. Pendle is also equipped with a unique yield tokenization mechanism that helps users better manage yield with more precision and flexibility. Due to its popularity, the fast uptake of this protocol, enhanced TVL, and expansion to other realms within DeFi point to the possibility of it being a key player in the DeFi market. As long as Pendle continues to innovate and the governance community remains engaged and involved, Pendle is poised to deepen its impact into the DeFi space, adding even more value by addressing key issues surrounding yield stability and opening up new means of yield aggregation and betting.
As mentioned above, in the ever dynamic DeFi environment, the way Pendle has implemented yield tokenization is quite revolutionary thus making it a protocol worth exploring.