In recent years, decentralized finance (DeFi) has laid a solid claim to the throne of traditional finance, providing users with improved control over their finances and opportunities to increase profit. One of the recent developments to make this dream a reality is yield-trading protocols, which allow users to maximize their profits and yield.
Similar to assets’ prices, assets’ yield also fluctuates from time to time. In a bull market, an asset’s yield tends to rise in value, while the reverse is the case in a bear market. Fortunately, with a yield-trading protocol like Pendle Finance, crypto enthusiasts can always take advantage of price fluctuations, maximize their returns, and hedge against risks.
Today, we’ll be reviewing the pioneering yield tokenization protocol, Pendle Finance. We’ll highlight the platform’s operating mechanism, its primary use cases, tokenomics & governance, and fee structure.
What is Pendle Finance?
Pendle Finance is a permissionless DeFi protocol that facilitates tokenising and trading future yield via an automated market maker (AMM) system. Deployed on the Ethereum network and EVM-compatible chains – Arbitrum and Avalanche, this yield-trading protocol provides a platform where users can implement various advanced yield strategies. Pendle essentially allows individuals and protocols to maximize their profits, irrespective of the market conditions.
Launched on Ethereum in June 2021, Pendle Finance went live as the first yield tokenization protocol on the mainnet. And since coming onto the scene, this protocol has gone on to become one of the fastest-rising projects in the DeFi space, with a total value of $45.7 million locked across three chains. Moreover, Pendle boasts a framework that supports other DeFi platforms, including Compound and Aave.
Pendle Finance’s primary goal is to provide an ecosystem for crypto enthusiasts who hold yield-generating assets – with time decay, enabling them to boost their profits and lock in potential gains upfront. In addition, the protocol aims to provide traders with direct exposure to future yield streams, without requiring underlying collateral. To make this possible, Pendle employs three essential components, namely;
- Yield Tokenization
- Automated Market Maker (AMM)
How Does Pendle Work?
To fully comprehend how Pendle works – and creates a yield market in the DeFi world, it is essential to know certain terms unique to the platform. Acronyms, such as SY (Standardized Yield), PT (Principal Token), YT (Yield Token), are central to the operating mechanism of the protocol. Here’s a link to a full glossary of terms that we’ll be using to describe how Pendle works.
Now that you have done that… let’s move on!
Owners of yield-bearing tokens, like aUSDC, SLP, and gOHM, can deposit their assets into Pendle. This protocol then wraps these yield-generating assets into SY (Standardized Yield), a token standard designed to facilitate interaction with an asset’s yield-generating mechanism and consisting of the principal and yield components, PT and YT, respectively. As such, depositors of yield-bearing tokens can mint a principal token and yield token.
Holders can use the yield token in a variety of ways. For instance, they can deposit the YT into Pendle’s AMM to provide liquidity to the protocol while receiving swap fees and other Pendle incentives in return.
Also, Pendle allows owners to sell their YT for money upfront, enabling them to set the interest rates and lock in profits instantly; on the flip side, Pendle users can purchase yield tokens directly without needing to own a yield-bearing asset.
With the yield token – which represents the owner’s right to potential profits, Pendle creates an effective and capital-efficient yield market, where traders (or new owners) can gain exposure to future yield. They can enhance their yield exposure in bull conditions and hedge against yield risks during bear conditions. However, it is worth noting that the YT can only be traded up until its expiry when it would no longer have value.
When a yield token reaches maturity, it stops generating yield. At this point, the YT owner can either redeem the principal token for the underlying yield-bearing asset from Pendle or roll over to a new expiry. However, to carry out any of these actions, the YT owner is also required to hold the principal token.
Pendle Finance features both a Simple UI and a Pro UI, which operate an identical set of contracts and utilize the same tokens. While the Simple interface is designed to execute Pendle’s primary functions that generate the highest traffic – to provide users with a seamless experience, the Pro interface offers the full package of functions on Pendle. Here, we’ll be highlighting the major use cases of Pendle Finance on both interfaces.
- Purchase Assets at a Discount
Users can employ Pendle in buying assets at less than the market price. This is possible because the protocol splits yield-bearing assets into a principal token and a yield token. Since the monetary value of the asset will also be divided, the principal token will be priced lower.
Once the maturity date is reached, the principal token can be redeemed for the underlying yield-bearing asset. However, it is worth noting that you decide to take profit even before the fixed maturity date. Without owning the yield token, this means you will be able to claim the asset at less than the market price.
- Provide Liquidity
Pendle also allows its users to provide liquidity to Pendle pools. The liquidity providers receive swap fees and other incentives as rewards. Different Pendle pools have varying APYs (Annual Percentage Yields), which are calculated by trading volume and PENDLE incentives (determined by the protocol’s governance.
Governance & Tokenomics
Pendle Finance has its own token, PENDLE, which is the core of the protocol’s value accrual mechanics and management. It also doubles as the governance token when staked and locked into vePENDLE (or vote-escrowed PENDLE). As of the time of writing, PENDLE trades at $0.306, with a market cap of over $60 million.
The governance token, vePENDLE control Pendle’s governance. This token helps to decentralize further and stabilize the ecosystem, while also creating a sink for PENDLE in order to keep the token’s price stable. To receive vePENDLE, users need to stake and lock in their PENDLE tokens.
Furthermore, the value of vePENDLE – and its resulting governance might – depends on the amount of PENDLE staked and the duration of the lock-in period (a maximum of two years). The vePENDLE token decays over time, reaching zero value at the end of the lock-in duration. Users can then unlock their staked PENDLE.
Pendle obtains a 3% fee from all yield acquired by YT. All of this fee is distributed to vePENDLE holders. Additionally, a percentage of profit from matured PTs (not redeemed) will be proportionally shared between vePENDLE holders.
One of the protocol decisions that vePENDLE holders make via governance and voting is incentive channelling. vePENDLE holders decide the flow of incentives to various pools, rewarding LPs in the pool they vote for. Voting for a pool makes vePENDLE owners eligible to receive 80% of the accrued swap fees, which are distributed proportionally amongst all voters of the pool.
There are other benefits attached to participating in Pendle Finance’s governance. For example, the LP Reward Boost program increases users’ incentives (up to 250% depending on the vePENDLE value) when they provide liquidity while also holding vePENDLE.
Pendle Finance Fees
Pendle Finance primarily charges two types of fees, and they include;
- Swap Fees
Swap fees on Pendle typically vary, depending on the proximity of the maturity date. For example, the swap fee is 0.1% of the exchange when it is one year to maturity. However, the rate is higher if the time to maturity is longer and lower if the time to maturity is shorter.
20% of these fees are allotted to liquidity providers, while the remaining funds are obtained as protocol revenue, which is distributed proportionally amongst vePENDLE holders.
- Yield Fees
Pendle obtains a fee of 3% from all yields acquired by YT. This fee is also received as protocol revenue and shared amongst all vePENDLE holders, depending on their respective vePENDLE value.
It is important to note that Pendle’s fee structure is subject to future changes via the protocol’s governance.
Overall, Pendle Finance is an excellent platform that eases the process of yield tokenization and trading. With the protocol’s unique features, including a decentralized governance framework and innovative fee structure, Pendle continues to set the pace in the world of yield trading – and DeFi as a whole. Moreover, the protocol’s tokenomics gives users the opportunity to hold a stake in its decision-making and, as such, its growth and development.
Pendle Finance has shown tremendous promise to become a leading protocol in the DeFi ecosystem in the coming years. With its integration on popular DEXes, like Camelot, it is only a matter of time before Pendle becomes the go-to option to leverage DeFi for financial gain.
[Editor’s Note: This article does not represent financial advice. Please do your research before investing.]
This article is done by our freelance writer, Opeyemi Sule
Featured Image Credit: Chain Debrief