Pendle Finance - Deep Dive
With Arbitrum exploding and LSD wars heating up, why not take a deep dive into a project perfectly positioned to capture some juicy juicy yield...
Note: Bottom half of the deep dive has alpha and predictions
Overview:
Yield fluctuates just like token prices. Tending to go up in bull markets and down in bear markets. Pendle’s goal is to provide their user with the maximum amount of yield, by simply increasing your yield exposure in the bull market and hedge against yield downturns during the bear markets.
Pendle is a permission-less DeFi yield-trading protocol, where users can execute various yield management strategies.
First they wrap yield-bearing tokens into SY(standardized yield tokens). Then, SY is split into their principal and yield components, PT (principal token) and YT (yield token) respectively, which allows them to be traded via the custom V2 AMM.
In Tradfi, institutional players rely on various hedges to protect their positions, such as future yield contracts.
The goal of this system is to onboard the gigantic derivatives market (worth over $400T in notional value) into DeFi.
By creating a yield market in DeFi, Pendle unlocks the full potential of yield. Pendle enables users to execute advanced yield strategies, such as:
Long assets at a discount
Fixed yield for low-risk, stable growth
Leverage exposure to future yield streams without the need for collateral
A mix of any of the above strategies
How it works:
Pendle liquidity providers (LP’s) get zero impermanent loss (IL) by simply holding your position to full maturity. All Pendle pools pair PT against their underlying asset. For instance, the stETH pool has PT-stETH paired against stETH.
But what is PT-stETH?
PT = Principal Token. All PTs can be redeemed 1:1 for the underlying upon maturity. Which means, all of the PT-stETH in the pool can eventually be used to redeem for stETH. The same goes for other pools too. Given enough time, all PTs = Underlying Asset.
Knowing this, it wouldn't matter if the pool consists of:
🔹50 PT-stETH + 50 stETH or;
🔹90 PT-stETH + 10 stETH
For all intents and purposes, upon maturity, both of these contain 100 stETH.
Zero IL.
Before maturity, there may be fluctuations in the price ratio of PT:Underlying, which can lead to minor, temporary IL.
But as long as you hold to maturity, LP-ing on Pendle can be a viable way to stack yield on top of your longs, or an effective way to accumulate assets like LSD.
Strategies
Buying PT:
If you believe that the yield of the asset will fall, you would want to hedge your yield. You can achieve this by buying PT. Since you are guaranteed the underlying asset after maturity, you are effectively locking your APY at the current Implied Yield when you buy PT. Another way to look at it is that you are fixing your yield at the current Implied Yield.
For example, if you buy PT-aUSDC with a maturity period of 1 year at 5% implied yield, it means that for every USDC you spend on PT, you will get back 1.05 USDC upon maturity and redemption.
Buying YT:
On the other hand, if you believe that the yield of the asset will rise, you would want to bet on your yield. By buying YT, you are increasing your exposure to the yield of an asset by only buying the yield component, and your returns will be determined by the fluctuations in the underlying APY.
Furthermore, buying YT is much more capital efficient than buying the underlying asset, meaning that for the same amount of capital, you can purchase a much larger quantity of YT, therefore compounding your exposure to yield.
For example, if the price of YT is 5% the price of the underlying asset, any increase in underlying yield will result in a 20x increase in your returns, since you are able to purchase 20x units of YT.
Liquidity Provision:
If you believe that the yield of an asset will be unlikely to fluctuate significantly, you can simply provide liquidity in our pools to earn some extra yield from swap fees and incentives.
There is no IL risk from fluctuations in the price of the underlying asset that most other yield protocols have, as the price of PT and YT are linked to the price of the underlying asset, in that PT + YT = underlying. The only IL risk comes from fluctuations in the demand for PT and YT, which are inherent in all liquidity pools.
IL is capped and minimized if liquidity is provided to maturity. This is possible as both assets provided have the exact same value at maturity. This way, liquidity provision can also act as a hedge for any of your PT or YT positions.
Another example:
Suppose you have 100 $aUSDC in your custody. With a 5% APY, you will have 105 $aUSDC in your wallet after a year.
Instead of waiting a year, you can split your $aUSDC into 100 $aUSDC-PT and 5 $aUSDC-YT with Pendle.
You now have a number of options.
If you think the yield will fall:
You can immediately profit by selling your $aUSDC-YT on the market for $5. To redeem your principal, you will need to buy back the 5 $aUSDC-YT (hopefully at a lower price) at a later date.
If you just want to lock in your yield without speculating, you can sell the YT for $5 and use the money however you want.
Return in a year and your principal will be unlocked. You simply tokenized your future yield and used it now. Pretty neat.
Tokenomics:
(PENDLE distribution as of OCT-2022)
Team tokens vest up to April 2023. Beyond this, any increase to circulating supply will be contributed by incentives and ecosystem building.
Weekly emission as of Oct-2022 is 667,705 with a 1.1% decrease each week until April 2026. At this point, the current tokenomics allow for a terminal inflation rate of 2% per annum for incentives.
($PENDLE supply)
vePENDLE
Pendle’s governance is powered by Vote-escrowed PENDLE, or vePENDLE.
vePENDLE enables Pendle to be further decentralized. With vePENDLE, an array of new features are unlocked for PENDLE holders, increasing the utility of the token.
As a result, it also creates another sink for the PENDLE token, giving more stability to the price of the token and to the protocol.
Getting vePENDLE
Lock PENDLE and receive vePENDLE. Your vePENDLE value is proportional to the amount and duration staked (up to a maximum of 2 years).
Your vePENDLE value will decay over time, and reaches zero once the lock duration is over. Your staked PENDLE will then be unlocked.
To increase your vePENDLE value, you can choose to extend your staking duration and/or increase your staked amount.
Revenue Stream Flywheel:
Pendle collects a 3% fee from all yield accrued by YT. Currently, 100% of this fee is distributed to vePENDLE holders, while the team collects no revenue. This is subject to change in the future.
A portion of yield from matured unredeemed PTs will be distributed pro rata to vePENDLE holders as well.
For example, matured PT-aUSDC is equivalent to aUSDC. If left unredeemed, all of its yield will be converted to a stablecoin and collected by the protocol as protocol revenue, and distributed to vePENDLE holders.
All of these rewards will be converted to USDC regardless of where your vePENDLE is being held and distributed periodically by a disbursement contract.
Incentive Channeling:
vePENDLE powers the incentive channeling mechanism on Pendle. vePENDLE holders vote for and direct the flow of rewards to different pools, effectively incentivizing liquidity in the pool they vote for.
Intuitively, the higher your vePENDLE value, the more incentives you are entitled to channel.
A snapshot of all votes is taken at the start of every epoch on Thursday, 00:00 UTC and the incentive rates for each pool is adjusted accordingly.
Voting for a pool also entitles vePENDLE holders to 80% of the swap fees collected by the pool, distributed pro rata between all voters of the pool.
LP Reward Boost
If you LP in a pool while you are holding vePENDLE, your PENDLE incentives and rewards for all of your LPs will be further boosted as well, by up to 250% based on your vePENDLE value.
Although your vePENDLE value decays over time, your LP boost rate is calculated at the time the boost is first applied. The boost rate will remain constant until you update your LP positions, in which case the rate will change based on your current vePENDLE value.
To receive boosted rewards, you should lock your PENDLE into vePENDLE first before LPing.
If you are already LPing and want to boost your rewards with vePENDLE, you have to manually apply the boost after voting for the pool.
Narrative
How this fits into the bigger picture:
In DeFi, we all love to make the comparison to tradfi and say something along the lines of “there’s 400T in notional derivatives, if we just capture 1% of that, DeFi’s ecosystem will do a 50x etc”.
While true, it’s important to stay realistic in where we are in comparison to traditional money. Yes I think we eventually start taking market share from tradfi, but to the extent that we become a concern to them will probably take at least 5-10 years. dYdX’s founder, Antonio Juliano has the same opinion that we don’t really start to see mass adoption in the same time horizon.
One of the biggest reasons for this is the boring topic of legalization and what is and isn’t allowed by leading nations. We’ve seen the recent news of Kraken being targeted for staking services and being deemed a security. Whilst most of us would agree this is rather outrageous, due to FTX’s collapse, we’ll probably see the forceful hand of the SEC more commonly than we’d like to for the foreseeable future.
I’ve been enough of a debbie downer for now, let's talk about how the infrastructure will play a big part in adoption. We’ll see the creation of tooling that will lead us to mass adoption far before the general public realizes it, partly because legislation will shun DeFi from growing, but also because the user experience is far behind traditional counterparts.
If we look at how tradfi operates yields, a regular person who wants to invest in bonds can purchase and hold them through a brokerage firm/online broker. The brokerage firm will handle the custody of the bonds and manage the account on behalf of the investor. This means that the physical bonds will be held by the brokerage firm, and the investor will receive regular statements showing their ownership and the details of their investment.
When an investor buys bonds through a brokerage firm, the bonds are held in the investor's account with the brokerage firm, and the interest payments are credited to the account. The brokerage firm will also typically handle the maturity of the bonds, including the repayment of the face value of the bond at maturity.
With this in mind, we see the user experience is mostly delegated to the brokerage firm where the user doesn’t have to worry about custody. While this would be seen as a negative in our decentralized world, the majority of accumulated wealth large enough to prosper off this incentive are 40+ years old and not as up-to-date with web 3.
Pendle Finance is offering the same service but instead you become your own brokerage, whilst also not having to trust third parties. Not only do you have the freedom of self-custody, but you now can leverage your own yield or de-risk depending on your financial forecasting.
Giving users the option to customize every aspect of their yield strategies will be a continuous trend in DeFi. Market makers/LP’s can hedge against positions much more efficiently with Pendle’s liquidity provisions, allowing bigger players to enter due to less volatility. Most don’t consider what is needed to onboard the bigger players, the answer is battle-tested smart contracts and liquidity.
In what conditions does this project excel:
Typically I’m a strong advocate for new projects, but Pendle launched back in the last bull run and saw low activity throughout the last year, up until recently. The team has been constantly innovating, moving fast with new partnerships and adapting to new ecosystem designs.
Pendle Finance has been a yield strategy innovator, which is why I believe they will benefit from the upcoming EIP-4844 upgrade, which will make roll-ups 20-100x cheaper. The Arbitrum ecosystem is soon to be in the spotlight as economic conditions are about to favor the products and applications greatly. DeFi was always held back due to high fees and unscalable technology, now that this barrier no longer exists, we’ll see an increase in user activity.
What I find most interesting at a high level is the ability to create yield through multiple ecosystems due to vePENDLE. As stated earlier, if you LP in a pool while you are holding vePENDLE, your PENDLE incentives and rewards for all of your LPs will be further boosted as well, by up to 250% based on your vePENDLE value.
This gets particularly interesting if you consider the recent surge in liquid staking derivatives (LSD’s). With them picking up steam, so too will Pendle, and in turn, this value flows back to Aura, to balancer, Lido, RocketPool and vice versa. Depending on your risk tolerance, this can take single digit APY’s on assets such as stETH and supercharge them into double digit APY’s, while having little security risk since you can derisk through Pendle Pro’s yield strategies.
As DeFi matures, we’ll see more institutional players pile in due to this attractive yield and ability to supercharge safe assets such as ETH. Now that DeFi has learned from Terra’s downfall, it’ll be clear on what changes need to be made to provide yield with stable liquidity and pegging.
Liquidity providers have the option to de risk as IL gets capped and minimized if liquidity is provided to maturity. The only IL risk comes from fluctuations in the demand for PT and YT, which are inherent in all liquidity pools. This is possible as both assets provided have the exact same value at maturity. This way, liquidity provision can also act as a hedge for any of your PT or YT positions.
This is a step forward in the fight of minimizing impermeant loss and onboarding more liquidity, which is greatly needed for Pendle’s success.
With the Shanghai update coming in, I believe most will be looking at alternatives to maximize ETH yield since a layer of risk is now removed.
In what condition does the project not do well:
I’ll get the boring topic of legalization out of the way and say that if the SEC keeps targeting staking mechanisms as securities it’ll kill innovation and liquidity in the short term. But eventually founders will be pushed to move to more crypto native countries. We’re already starting to see this to some degree, it’s just a matter of when the SEC gives clear guidelines on what’s allowed.
Smart contract risk is huge here as this is a similar comparison to Lido where TVL greatly succeeds in market cap. If there’s any flaws, you can guarantee they'll be exploited. The team realizes this and has been very transparent with audits and will continue to do them into the future.
Another consideration would be centralized competitors offering better yield and custody. The average person is frightened by crypto’s complexity and would be more inclined to flee to the safety of a centralized actor who does the hard work for them. Maybe we’ll see people learn their lesson from recent collapses (FTX, Celsius etc), but when retail adoption comes back, I have a gut feeling that unless the user experience significantly improves, we’ll see uneducated users flock to centralized entities.
Due to being earlier days, competition will be rampant and I can imagine most companies are looking for a way to capture that juicy tradfi volume. Projects such as Aave have a huge lead in lending/borrowing, with their presence it wouldn’t be hard to add some customizable yield strategies and dominate market share like they’ve consistently done over the past few years. Liquidity is everything at the end of the day, if there’s no real bootstrapping of reliable providers, user activity can never take off.
Ecosystem development is never easy and requires a lot of manpower. Being a smaller project your presence isn’t as known and can be hard partnering with those who would benefit you the most. Unless the Pendle team keeps adding new partners for liquidity pools and incentives on other DEX’s/platforms, $PENDLE won’t see the light of day it deserves. They’ve got the infrastructure down, now it’s up to the team to prove they have the marketing talent needed to bring users to their product.
Opinion Zone
Where I think this project can go fundamental/price wise:
One of the best parts of DeFi’s ability to capture new participants is the shiny object syndrome of TVL. IMO, a large majority of Lido’s success came from its ultra high TVL which put more trust in its mechanism, leading to more people aping (monkey see, monkey do). Due to Pendle’s locking mechanism, we’ll see their TVL consistently outweigh market cap with incentive structures if price action isn’t too volatile. This looks good for valuations and proves to investors that they have product market fit.
Pendle to me is like an Aave on steroids, allowing for far greater customization and an in-house hedging option, meaning the user doesn’t have to go elsewhere. As stated before, liquidity is king here, if the team can manage to keep bringing in new ecosystems and creating noise, like what they’ve done with Camelot, then I think it has some rocketship potential.
The word is starting to go around between highly looked upon DeFi analysts and to myself it seems like a matter of time before it picks up in the layer 2 dApp wind. With LSD being the talk of the town and Shanghai around the corner, my gut feeling is there will be a new spark in DeFi activity from unstaked ETH and better scaling for roll ups. Pendle will be in a perfect position for hungry yield farmers looking to capitalize in a hot ecosystem.
With the recent addition of $wsETH and $rETH, there’s a clear vision that the Pendle team understands how big this unlock could be and the potential it creates for their ecosystem. You can now provide liquidity and get APY from 28-63%, pretty crazy for one of the safest investments you can make in crypto.
If Pendle did a 10x from here and hit $170M mc, it still would need to double to catch up to some of the big names. Based on recent marketing and upcoming events, even with the recent price surge from $0.04, I believe it could easily do 10x from $0.17.
Currently there is 27.5 million PENDLE locked, which is 18.3% of the circulating supply.
Keep in mind it has no exchange listings besides Gate.io so there’s more pumpamentals waiting in the fuel tank.
Charts and liquidity overview:
Liquidity: Currently across the four listed DEXs (Sushiswap, Camelot, Kyberswap and TraderJoe) there’s roughly $1.9 million in liquidity.
The only CEX it’s listed on is Gate.io so I can’t imagine there would be too much more liquidity, especially since the 2% spread is $500.
TVL is $27 million and consistently growing, previous ATH was $37 million back when the token was sitting around $0.8-$1, so current price isn’t reflective of TVL IMO.
Price levels to watch for:
$0.24
$0.33
$0.5
$0.8-$1
Then clear skys till $2 which was previous ATH.
My basis for hitting close to $2 in the next coming months is a steady continuation in ETH’s uptrend, especially important once the Shanghai unlock happens. Then seeing the explosiveness in Arbitrum and Optimism's ecosystem. Hopefully we see more LSD pools created and new partnerships to foster more liquidity.
As always, any support is greatly appreciated <3
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