Pendle Finance: Yield Tokenization and Stablecoin Deposits with a Fixed Annual Rate of 47%
#609
GM,
Blocktrend is going to resume the tri-weekly publication rhythm starting in July. Members will receive new content every Tuesday, Wednesday, and Thursday. On one hand, this is because my daughter can now be taken care of at a daycare center during the day, and on the other hand, we also speculate that a bull market is not far off.
Let me show you a chart first. This chart illustrates the total value locked in Decentralized Finance (DeFi), which is somewhat similar to government statistics on how much capital is currently invested in the stock and real estate markets. Over the past six months, the total value locked in DeFi has been continuously increasing. Although it has not yet reached an all-time high, it has returned to the levels seen during the bull market of 2021.
Whether growth will continue in the future remains uncertain. In the previous bull market, everyone was looking for DeFi applications worth participating in, but now people's interests differ significantly from the trends shown in the chart. Insiders prefer that fewer people know about profitable opportunities to avoid diluting returns, while outsiders look at those incredibly high yields with suspicion, wondering if this might be another trap.
In this DeFi mini bull market, the project worth watching the most is Pendle Finance. Pendle is the fastest-growing DeFi project of 2024, with a total value locked (TVL) of $6.7 billion, ranking fifth across the entire blockchain, positioned between MakerDAO1 and Uniswap in terms of scale.
The influx of funds into Pendle is largely driven by the attraction of fixed high-interest rates, but I would argue that market uncertainty is the main reason for Pendle's rapid rise. Managing uncertainties is where Pendle excels. Let me start by talking about TSMC.
TSMC Expansion
TSMC (Taiwan Semiconductor Manufacturing Company) is a source of uncertainty in Taiwan's real estate market. Recently, TSMC has been actively expanding its factories in Taiwan, building more and larger facilities. Real estate research institutions have found that wherever TSMC builds, property prices rise:
Kaohsiung's Nanzi and Qiaotou districts, previously classified as less desirable areas but with industrial parks, have seen significant property price increases since TSMC announced the establishment of new facilities. According to statistics from 591 New Construction, property prices in Nanzi have risen by 75% in the past three years.
TSMC's large workforce and high incomes attract investors who believe TSMC's new facilities will bring people and money to the area. Those who can catch wind of this early and buy properties before the news becomes public can potentially become landlords to TSMC employees. However, relying on insider information to buy property is risky, as demonstrated by the case in Longtan, Taoyuan. Investors rushed to buy property anticipating TSMC's arrival, only for TSMC to eventually decide not to proceed, leaving investors to bear the losses.
If real estate could be tokenized, people could manage risks through Pendle, potentially becoming landlords without actually buying the property, securing future rental income. Even if TSMC does not move in, they wouldn't be stuck with an entire property.
The Landlord's Choice
According to Pendle's introduction:
How much return can you earn by depositing 1,000 USDC on Aave? 1%? 3%? 5%? No one can say for sure. Deposit interest rates fluctuate unpredictably, much like cryptocurrency prices. Pendle splits yield-bearing assets into two types of tokens: Principal Tokens (PT) and Yield Tokens (YT). This process is called yield tokenization, which creates strategies such as fixed yield and long yield.
Let's get back to the real estate example. Suppose I have a house in Longtan, Taoyuan, that I want to sell for 10 million TWD. Pendle acts like a real estate agent proposing an idea to me: "There are rumors that TSMC might set up a factory here, and many investors are eager to become landlords. Currently, the annual market rent is 1 million TWD (for calculation simplicity). I suggest you divide the property into two contracts to sell it faster. One is for ownership, and the other is for rental income."
Ownership (Principal Token, PT): Sell for 9 million TWD, and you become the homeowner after one year.
Rental Income (Yield Token, YT): Sell for 1 million TWD, and you collect one year of rent; afterward, the token is worthless.
This satisfies two types of demand. Those who want to be landlords and collect rent can buy the rental income for 1 million TWD without having to pay 10 million TWD to buy the whole house. Lowering the investment threshold increases the number of potential landlords. If TSMC confirms its expansion into Taoyuan, local rents might double from 1 million TWD per year to 2 million TWD per year. Those who bought the rental income token would essentially earn 2 million TWD in rent for a cost of 1 million TWD, resulting in a 100% return on investment (100/100).
Those who bought the ownership token also benefit. They effectively bought a property with a "rental guarantee." Even if TSMC decides not to expand, the 1 million TWD they didn't pay upfront is equivalent to renting out the property for 1 million TWD. This represents a fixed income with an 11.11% return on investment (100/900).
If the homeowner ultimately decides not to sell and becomes a landlord themselves, and TSMC indeed sets up a factory, they would earn 2 million TWD in rent on a 10 million TWD property, resulting in an 18.18% return on investment (200/1100).
This example is intended to simplify the calculations and illustrate Pendle's functionality. A rentable property can be viewed as a yield-bearing token, and Pendle's role is to split its principal and yield, selling them separately to investors with different needs. Principal Token (PT) investors seek fixed future returns with lower risk. Yield Token (YT) investors aim for potential yield increases that the market hasn't yet realized, bearing relatively higher risk.
With this understanding, Pendle's interface becomes much easier to grasp.
Managing Yields
Let's start with the simplest case. The following diagram shows the yield figures for stETH on Pendle. stETH is an ETH staking certificate issued by Lido. Holding stETH automatically earns an annual staking yield of 3.3%, similar to participating in PoS staking with ETH. In Pendle's view, stETH is akin to a property that can generate 1 million TWD in annual rent, which can be split into ownership and rental income tokens.
As shown in the chart, the current price of one stETH is $3,680.5. Pendle splits it into two types of tokens, which are sold separately:
Ownership (Principal Token, PT): Sold for $3,598.13, redeemable for one stETH at maturity.
Rental Income (Yield Token, YT): Sold for $82.36, earning the staking yield of one stETH until maturity, after which it becomes worthless.
This contract matures on December 26, 2024. Your purchase decision depends on your prediction of future Lido yields, just as investors need to predict whether TSMC will set up a factory in Taoyuan.
If you believe something significant will happen before the maturity date to boost stETH yields, you should buy the rental income. For just $82.36, you can buy the future rental income of one stETH. This is more economical than holding one stETH at $3,680.5. If yields indeed rise, you earn the same yield for a fraction of the cost. Some might even find the rental income so cheap that they spend $8,236 to buy the rental income of 100 stETH and potentially earn even more.
However, be cautious; this is akin to leveraging. If your bet is correct, you earn the yield of 100 stETH at once, but if wrong, you lose at the same rate. The risk is higher.
If, like me, you prefer not to gamble on future yield fluctuations, buying the ownership is a more stable choice. You might earn less, but you won't lose money. By buying one stETH maturing at the end of the year for about $3,598.13 (the price of roughly 0.977 stETH), Pendle has calculated that this equates to a fixed annual yield of 4.245%. Future fluctuations in stETH yield won't affect you because you've locked in future returns at a discount when you made the purchase.
At this point, I can finally reveal the headline claim of a "fixed 47% stablecoin yield." At the time of writing, the USD stablecoin sUSDe offers a fixed yield of up to 46.98% on Pendle. The reason sUSDe can offer such a high fixed yield on Pendle, even double its current real yield of 23.82%, is that investors are optimistic about future airdrops for sUSDe.
Whether future airdrops will occur and how much they will be worth is something advanced investors will meticulously calculate. For the general public, a stablecoin with a fixed annual yield of 46.98% is already very attractive. Even if they "bet wrong," they still get a 46.98% annual yield, a market scenario unimaginable to outsiders.
These examples explain why Pendle, founded in 2021, only soared in 2024. Complex mechanisms take time to mature, and people's understanding of DeFi has significantly improved over the past three years. Moreover, Pendle is suitable for dealing with volatile markets. The more volatile the yield, the more suitable Pendle is for managing risk. Recently, many projects have announced airdrops2, introducing another factor of yield instability.
Pendle has achieved its current market position because it has become the best tool for managing yield risk, catering to both risk-averse and risk-seeking investors. Although Pendle currently supports only a few cryptocurrencies, governments worldwide are actively researching asset tokenization. The real estate example mentioned earlier is not entirely impossible. For Pendle participants, I have two reminders.
Risk Reminders
First, be cautious with Pendle; second, be cautious with the assets you hold.
Pendle is ultimately a more advanced DeFi tool with a high entry barrier. Despite the attractive yields, I do not recommend investing large sums all at once to avoid losses due to unfamiliarity with the mechanisms. The more complex a financial application, the higher the instability. Although Pendle currently has substantial capital and is not reliant on subsidies for survival like Anchor Protocol was345, it is still important to be wary of DeFi risks, including errors or hacks.
Even if Pendle's code is flawless, you still need to be cautious about the risk of the assets themselves. For instance, even if the USD stablecoin sUSDe offers a 46.98% fixed yield on Pendle, if the sUSDe stablecoin itself goes to zero, having a large amount of sUSDe would be worthless. Pendle can provide investors with additional returns, but using Pendle also means taking on an extra layer of risk.
Whether the extra yield is worth the risk is a question that will have different answers for everyone.
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