Lato-lato is the current craze where I live as of the time of this writing. And thank goodness coz while the ear-splitting clacks of this toy can be heard all over the town, it gave me an epiphany about a certain DeFi protocol that I’ve been dying to understand.
The protocol iz Pendle Finance. Most crypto apers miss this because admittedly the barrier to understanding what it does is high. But I think it’s a hidden gold mine just waiting to be discovered by the wider crypto public.
So… here we go. Pendle Finance is the DeFi counterpart of the $400T interest derivative market. By that, I mean it enables you to trade the fluctuations of interest rates.
In staking, you got this thing called APY that tells how much interest you’re getting for your crypto. But APY is not set in stone. A protocol may say it will be giving you 69,000% APY but only give you 6% by the end of the period. This is because APY changes depending on the supply and demand of the token you’re staking, how diluted it becomes, and even on how many participants are staking. So rather than just praying that you’ll get the promised yield for your staked crypto, you can actually trade the yield proactively on Pendle and have more control of your staking earnings.
Twin Balls: The Yield and The Principal
It all begins by splitting your staked token into two: the Principal Token (PT) and the Yield Token (YT). The PT can be redeemed 1:1 with your underlying token once the maturity date has been reached. Before maturity date, you can buy PT at a lower price and it will increase in token value until you can exchange it equally with the real token.
YT represents the yield for each underlying token. So if, for example, you deposited 5 staked ETH that has 5% APY, then you’ll get 5 YT to represent that 0.05 ETH yield for each token. If you wanted to short the interest rate, you sell some YT back into PT. But if you wanna bet that the APY will go higher, then you buy more YT. Say, you’re bullish that ETH staking rewards will go higher. You can just buy 100 YT-stETH and now you can get the increasing yield for 100 stETH without actually needing to buy 100 ETH.
But what’s the relationship between the PT and YT? Remember when I said you can buy PT at a lower price before maturity date? Well it gets that discount from the APY of your staked token. And since YT represents the APY from your staked token which you’re making redeemable through PT by the end of the period, YT loses its token value as time passes until it becomes zero at maturity date.
In short, the values of PT and YT move inversely correlated to each other over time… pretty much like lato-lato balls converging again after being split in opposite directions.
If you’re OC, here’s the exact formula for the relationship between the two tokens:
P(PT)+P(YT)=P(Underlying)
Now you know the rules of splitting. Jast keep lato-lato in mind because there are huge advantages to using Pendle that you can’t get anywhere else:
Fixed Yield Strategy
Pendle’s design enables participants to lock in the yields for their staked tokens. As you olredy know, the yields in your staking protocols are unpredictable and you never know what you’re gonna get in total. Dis causes headaches and uncertainty.
But remember, if you buy PT at an already declared APY (its implied yield), you are always guaranteed of the exact yield you’d be getting by maturity date. So how to lock in your yields? Just buy the PT of your choice token and hold til maturity date. Tadaaa, fixed yield.
PT Trading vs Spot Trading
Spot trading iz nice and all, until I realized you can also trade PT like they’re spot tokens. It does make sense because the value of the PT moves in parallel relative to its underlying asset. But compared to spot, PT also has a guaranteed fixed yield. The token literally multiplies. So if I ever make a losing trade, at least I can get some yield from holding a PT. And if I make a winning trade, I still get additional yield to sweeten the win… so, it’s really a no brainer decision to use PT to trade whenever possible.
Liquidity Providing with Zero Impermanent Loss
This is probably my favorite. Pendle pools are pretty spooky because you always know how it ends up on maturity date: you get back your investment at the same token value. This is because PT is equal to your underlying asset by the end of the period. And if they have the same value, then there will be no impermanent loss eventually.
How do you use this to your advantage? Well if you’re just planning to hold a staked token for a long time, you can get free money by putting it in Pendle’s liquidity pool and earn incentives, swap fees, PT yield, as well as staking rewards. All that is risk-free, because read the previous paragraph anon. I can’t be any more excited for staker frens 🐴💖
A Use Case for Simple Personz
Us plebs may not even want to trade interest rates or participate in liquidity pools. It still has some use for us though. Say danki wanna buy ETH and is planning to hold it for the long term. I will likely get the best discounted prices at Pendle, because PT haz yield. The catch is that I can only redeem them at a later date, but since I’d be holding the tokens for a long while anyhow, the waiting time wouldn’t matter.
Buying PT can actually serve as a big discount voucher to any token you wanted to buy and hold. Simple enough if you just wanna ape :D
Another DeFi Poetry
As you see, the token-splitting mechanism that started it all seems very unique, and that is because it has its own token standard. Once a yield-bearing token is provided to Pendle, they create an SY token behind the scenes which is what the protocol uses to interface with the original token you provided. From there, they mint your PT and YT.
The interesting thing is that SY tokens might have a use outside Pendle because it literally made a standard interface for protocols to interact with yield-bearing tokens in a generic yield-generating pool. It might eliminate any protocol’s need to use custom code when dealing with the special mechanisms of these pools and yield-bearing tokens. I might go back to this in detail in the future!
The AMM is interesting too… since we’re trading yield, the range gets pretty narrow and predictable and the model almost mimics a concentrated liquidity pool. So the trading range is easily set and the users benefit from lower price impact and better capital efficiency for LP-ers.
I kan sense some frends’ brainz are screaming olredy. It’s normal tho, Pendle is one of the more unique protocols I reviewed. Danki almost cried from trying to understand some token splittin mechanisms haha.. But we made it! We have a detailed explainer of one of the most novel DeFi protocols that I think is gonna be big in the future.
I hope you lerned something. Next time I want to talk about primitive pools where the liquidity curve dynamically changes over time. Or maybe I’ll just donkey around and write something lighter and funnier. Whatever it is, thenks for hanging out in here. Ciao!
