The Context

At the heart of DeFi, yield farming products have been instrumental in attracting users and capital, offering enticing opportunities to earn returns on cryptocurrencies. However, the state of yield farming products has often been marked by complexity, risk, and uncertainty. Users are confronted with an array of challenges, from navigating the intricacies of various DeFi platforms to coping with the volatile nature of crypto markets.

The concept of yield tokenization, which is critical to the DeFi ecosystem, has not yet gained widespread adoption despite being an innovative concept that offers significant potential benefits. 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.

One such innovation that has been making waves is Pendle Finance, a groundbreaking DeFi protocol that is reshaping the way we think about yield optimization and trading. By enabling users to tokenize and trade yield from various DeFi protocols, Pendle Finance with its token, $PENDLE, has introduced a new level of flexibility and accessibility to yield-bearing assets, which could mark a significant shift in the DeFi landscape.

In this article, we embark on a journey to explore the profound impact of Pendle Finance on the DeFi landscape. We'll delve into the core features that set Pendle apart, such as the tokenization of future yields and its advanced automated market maker (AMM) system. We'll examine how Pendle empowers users to maximize their profits and secure gains in any market condition, all while simplifying the complexities of yield farming.

Unveiling Pendle Finance

Pendle Finance officially launched in June 2021. The project was spearheaded by a group of anonymous developers known by their pseudonyms: TN Lee, GT, YK, and Vu. Headquartered in South Korea, Pendle quickly garnered attention and support from prominent investors, including Bitscale Capital, Crypto.com Capital, Fisher8 Capital, and Strategic Round Capital, who collectively injected $3.7 million in funding. In July, 2023, Pendle was listed on the Binance Launchpool and Binance’s Innovation Zone.

Pendle Finance is a permissionless DeFi protocol that enables the tokenization and exchange of future yields through an automated market maker (AMM). Operating on the Ethereum network and compatible with EVM-based chains like Arbitrum and Avalanche, Pendle Finance provides a versatile playground for users to deploy advanced yield strategies. Whether the market is bullish or bearish, Pendle empowers individuals and protocols alike to optimize returns and gain control over their financial destinies.

At its core, Pendle Finance seeks to establish a digital ecosystem for cryptocurrency enthusiasts holding yield-generating assets. With the added feature of time decay, Pendle enables users to maximize their profits and lock in potential gains in advance. Additionally, the protocol offers traders direct access to future yield streams without the need for underlying collateral. This is made possible through three fundamental components:

  • Yield Tokenization
  • Automated Market Maker (AMM)
  • Governance

In the traditional finance sector, institutional players rely on various hedging mechanisms to safeguard their positions, and this takes the form of future yield contracts in TradFi, which make up a substantial portion of the interest derivative market with an estimated value of over $400 trillion in notional value. However, these mechanisms have not been available to DeFi players  -  until Pendle.

Unlike traditional yield farming, which is limited to staking or providing liquidity to AMMs, yield derivatives offer greater flexibility and stability to DeFi users. With Pendle, users can access a wider range of yield-bearing assets and gain exposure to future yield without the volatility of traditional yield farming. Pendle aims to bring the yield derivatives market to the world of decentralized finance.

How Pendle Works?

Yield Tokenization

To comprehend Pendle's inner workings, it's essential to familiarize ourselves with specific terms unique to the platform. Acronyms such as SY (Standardized Yield), PT (Principal Token), and YT (Yield Token) form the bedrock of the protocol's operational mechanism.

The process begins when owners of yield-bearing tokens, such as stETH, cDAI, and yvUSDC, deposit their assets into Pendle. These assets are then bundled into a token known as SY (Standardized Yield), which streamlines interaction with the asset's yield-generating mechanism. SY consists of two primary components: PT and YT. Consequently, depositors of yield-bearing tokens can mint both principal tokens and yield tokens.

PT represents the underlying staked asset, while YT embodies the future yield of the staked asset. Pendle's approach can be likened to the traditional financial practice of bond stripping, where principal and interest are separated. Here, PTs are akin to zero-coupon bonds, and YTs represent the isolated coupon payments.

YT tokens serve various purposes for holders. They can be deposited into Pendle's AMM to provide liquidity to the protocol, earning swap fees and other incentives in return. Additionally, Pendle offers owners the option to sell their YT tokens for immediate monetary value, permitting them to set interest rates and lock in profits promptly. Users can even purchase YT tokens directly without requiring ownership of the underlying yield-bearing asset.

Through the issuance of YT tokens, which embody ownership of potential profits, Pendle facilitates an efficient and capital-efficient yield market. Traders can amplify their yield exposure during bullish market conditions and safeguard against yield risks in bearish conditions. It's worth noting that YT tokens are tradeable until their expiry date, beyond which they lose their value.

Upon maturity, when a YT token ceases to generate yield, the token holder faces two choices. They can either redeem the principal token (PT) for the underlying yield-bearing asset from Pendle or opt for a rollover to a new expiry. Importantly, these actions necessitate possession of the corresponding PT token.

Pendle's AMM

While both PT and YT tokens are tradeable, the majority of existing automated market makers (AMMs) are ill-suited for trading YT tokens. Traditional AMMs rely on constant formulas like x * y = k, which do not factor in the element of time or the fact that YT tokens ultimately depreciate to zero at expiry. Pendle addresses this challenge by introducing its native AMM, which incorporates a time-decaying factor, facilitating YT token trading.

Pendle's V2 Automated Market Maker (AMM) is tailored specifically for trading yield, honing in on the unique attributes of Principal Tokens (PT) and Yield Tokens (YT). The AMM curve adapts as time progresses to accommodate the yield earned, narrowing the price range of PT tokens as they approach maturity. This concentration of liquidity within a specific range enhances the efficiency of trading yield, particularly as PT tokens near maturity.

To facilitate PT and YT swaps, Pendle has designed a specialized system inspired by Notional Finance. It employs a single pool of liquidity for trading, simplifying PT token swaps by exchanging them directly with the other asset in the pool. For YT tokens, Pendle employs flash swaps within the same pool, ensuring swift and efficient transactions.

Pendle has integrated an automated routing feature, permitting users to trade PT and YT tokens with their preferred major asset. The relationship between PT and YT tokens enables seamless YT swaps within the PT/SY pool.

When acquiring YT tokens, buyers send their SY tokens into the swap contract. The contract then withdraws additional SY tokens from the pool, providing buyers with PT and YT tokens. PT tokens are sold for SY tokens to recover the initial amount.

Conversely, when selling YT tokens, sellers transfer them to the swap contract, which borrows an equivalent amount of PT tokens from the pool. YT and PT tokens are then employed to retrieve SY tokens, which are either returned to the seller or exchanged for other major tokens. A portion of the SY tokens is sold back to the pool for PT tokens to repay the borrowed amount.

Pendle's V2 design minimizes impermanent loss (IL). The AMM curve accounts for PT's natural price appreciation over time, aligning its value with the underlying asset. This diminishes IL over time. Furthermore, IL arising from swaps is further mitigated due to the high correlation between the assets in the PT/SY pool.

Pendle's AMM curve can be tailored to accommodate tokens with varying levels of yield volatility. By concentrating liquidity within a predictable yield range, larger trades can be executed with minimal slippage. This customization enhances capital efficiency and augments the trading experience.

PENDLE Tokenomics

PENDLE

PENDLE is the native token of the Pendle Protocol, serving as the currency that governs protocol operations and value accrual. Operating as an ERC-20 utility token, PENDLE boasts a total supply of 231,725,335 tokens, with a maximum supply capped at 251,061,124 tokens.

PENDLE 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 $0.67, with a market cap of over $150 million.

It's worth noting that PENDLE tokens are fully vested in April 2023, before Binance's Launchpool. The whitepaper details that the allowed terminal inflation rate for the PENDLE total supply will be 2%.

One of the key functions of the PENDLE token is to provide liquidity to the protocol’s pools. Users who provide liquidity to Pendle pools are rewarded with PENDLE tokens, which can be staked to earn additional rewards. In addition, PENDLE tokens are used to pay transaction fees within the platform, which helps to ensure that the network remains secure and efficient.

Another important use case for the PENDLE token is governance participation. PENDLE token holders have the ability to participate in the platform’s governance process, including voting on key decisions related to upgrades, changes to the protocol’s parameters, and other important matters. This ensures that the platform’s decision-making process is decentralized and reflects the interests of its users.

Pendle generates revenue through a 3% fee on all yields acquired by YT tokens, with this fee distributed to vePENDLE holders. Additionally, a percentage of profits from matured PTs (not redeemed) is proportionally shared among vePENDLE holders. These governance decisions include incentive allocation, with vePENDLE holders determining the distribution of rewards to different pools, making them eligible to receive a significant share of accrued swap fees.

vePENDLE

Pendle's governance system empowers PENDLE token holders to actively participate in shaping the platform's future. This participation is facilitated through vePENDLE tokens, which are essentially vote-escrowed PENDLE tokens. To obtain vePENDLE, PENDLE tokens must be locked (staked) in Pendle for a specific duration, which can extend up to two years. The quantity of vePENDLE received is contingent upon the staking duration, and the value of vePENDLE in a user's wallet gradually diminishes over time. Once the staking period concludes, the locked tokens are released, and vePENDLE value reaches zero.

By amassing vePENDLE tokens, users can amplify their influence and entitlement to incentives. Achieving this entails extending the staking duration and/or increasing the amount of PENDLE staked. vePENDLE tokens play a pivotal role in Pendle's incentive mechanism. Holders of vePENDLE can cast votes and direct the allocation of rewards to different pools, effectively promoting liquidity provision in the pools they support. At the commencement of each epoch, a snapshot is taken of all votes, and incentive rates for each pool are adjusted accordingly.

Currently, Pendle collects a 3% fee from all yield earned by YT tokens, with 100% of this fee distributed to vePENDLE holders. The protocol itself does not retain any revenue from this fee collection. It's important to note that this distribution model may undergo modifications in the future. Additionally, a portion of the yield from matured unredeemed PT tokens is distributed proportionally to vePENDLE holders. vePENDLE holders are further incentivized through liquidity incentives, with the ability to vote for the allocation of liquidity incentives to different pools. Those who have voted for a particular pool collectively receive 80% of the swap fees generated by that pool.

Conclusion

In summary, Pendle Finance is at the forefront of DeFi, pioneering a revolutionary concept: yield derivatives. In a DeFi landscape filled with complexity and volatility, Pendle simplifies and secures yield optimization.

Yield farming in DeFi has been akin to navigating a maze blindfolded, but Pendle changes the game by providing users with a clear path to maximize returns. With tokenized future yields and an advanced AMM system, users gain control and predictability.

What sets Pendle apart is its commitment to decentralization and community-driven governance through vePENDLE tokens. This democratizes finance, offering a refreshing departure from traditional centralized systems.

As Pendle's ecosystem expands, integrating with major DeFi platforms and blockchains, its influence will grow, benefiting more users and strengthening the DeFi community.

Pendle Finance is a beacon of innovation, bridging traditional finance with decentralized ideals. Whether you're a DeFi expert or a newcomer, Pendle Finance simplifies yield farming, making it accessible, secure, and rewarding for all.

In Pendle Finance, the future of yield optimization has arrived, and it's here to stay.