Last week, Binance Labs announced an investment into Pendle Finance for an undisclosed amount. The news was hardly surprising, as Binance had listed Pendle 2 months ago.
Pendle has been making a lot of waves with its yield trading system. We're going to explore in this post how you can earn additional yield on your sfrxETH and even trade future yield outcomes with Pendle Finance.
What is Pendle Finance?
Pendle Finance is a permissionless yield-trading protocol that allows users to manage and maximize their yields. Pendle does this through “Standard Yield” (SY) tokenization. These SY tokens are then divided into two components: the principal token (PT) and the yield token (YT). This allows users to trade an asset's principal separate from its associated yield.
What is Pendle Earn and Pendle Trade?
The protocol offers two distinct platforms: Pendle Earn and Pendle Trade.
Pendle Earn abstracts away all the complex parts of the protocol and offers a simple fixed yield.
In contrast, Pendle Trade is designed for active trading of PT and YT.
What are YT and PT tokens?
Yield Token (YT): YT captures the yield component of an underlying yield-bearing asset. For sfrxETH, this would be the ETH earned until maturity. Holding YT gives rights to the continuous yield generated by the underlying asset, which is represented as "Underlying APY" within the Pendle interface.
What’s cool about this is that investors trade future yield expectations in real-time. Essentially, purchasing YT means going "long" for the yield of the underlying. One can buy “cheap” YT and then if the Underlying APY goes up, so does the price.
Principal Token (PT): PT, on the other hand, embodies the principal or the initial value of the yield-bearing asset. Upon the token's maturity, PT can be exchanged at a 1:1 ratio for the underlying asset.
For example, if a user possesses 1 PT tied to a certain asset like stETH, upon maturity, it can be redeemed for the equivalent value in stETH. A noteworthy trait of PT is that its value, while initially less than the underlying asset due to the extraction of the yield component, will gradually converge with the asset's value as it nears its maturity date. This predictable appreciation towards the underlying asset's value by the maturity date forms the basis of its Fixed Yield APY.
Additionally, PT can be traded freely at any stage, regardless of its proximity to maturity.
What's the price relationship between PT and YT?
The relationship between the prices of PT (Principal Token) and YT (Yield Token) stems from how Pendle's mechanism divides an underlying yield-bearing asset into its principal and yield components.
Ideally, the combined market values of PT and YT should equal the current value of the original asset.
The price of YT is determined by the market's projections of future yields.
A higher anticipated yield increases YT's demand and price, while lower expected yields or perceived risks reduce its value.
As for PT, its price is set to converge with the value of the underlying asset as the maturity date nears. This is because PT can be redeemed for the underlying asset at a 1:1 ratio upon maturity.
Consequently, YT's value decreases as the maturity date approaches since its worth is confined to the yield accrued until that date.
How to Trade sfrxETH yield on Pendle
In the picture above, the blue line is the implied yield at maturity, the green line is the last 7 days average yield. The green line is a good indicator of what the current mood of the market is.
So when trading on Pendle, the blue line is what matters. It is the implied yield based on the price of PT+YT at maturity. The idea should be to sell YT tokens at the absolute peak and then wait for implied yields to decline and rebuy YT.
In the example above, there are two options.
- Buy YT with ETH and speculate on the yield. If the implied yield goes down after you sell the token, you make money. This method provides leverage, as the cost of the YT tokens are a fraction of a whole ETH.
However if you buy YT and the implied yields go down, you will lose money.
- Mint PT and YT with sfrxETH or ETH. Then when the market is right, sell either to try and time implied yields rising or lowering.
Using the handy calculator, let's go through a couple of examples.
Right now the implied yield (blue line) for sfrxETH is approximately 5.14%. If you buy YT and the average future rate at maturity is approximately 5.14%, you won’t make any money. It will be a flat trade.
However, if the average rates for sfrxETH go to 6.14%, you will earn a net profit of 19.7, as you are buying undervalued yields.
On the other hand, if the average yield drops to 4%, well then you effectively bought overpriced yield and suffered a 20% loss. Additionally, if you mint and sell your YT, you can buy it back later and earn the extra yield.
Ok, but what if yields go down?
Up until recently there has been no effective way to short YT, however, Dolomite just launched a borrowing market to be able to short YT effectively now. These money markets would most likely be added to sfrxETH once the TVL size becomes large enough.
If you don’t want to speculate you can add your sfrxETH to the trade pools, so that other people can get YT liquidity to trade with. Right now the rates are 7%
And if you are super cautious and want to lock in a fixed rate, you can use Pendle Earn to lock in a 5.2% yield. One great thing about Pendle Earn is that you don’t have to wait until the product matures to get your ETH back. You can sell it at any time with their AMM.
So to recap the yields you can earn at Pendle Finance today are:
- Pendle Earn 5.2%
- Pendle Trade Liquidity 7-10.1% (dependent on vePendle)
- Trading PT + YT, dependent on your ability to profit from selling or buying YT.