Pendle — Base Use Cases & Strategies

08 Jun Update: As of June 8th, XYT has been renamed to YT.

With the rapid development in DeFi, numerous yield-generating assets have been created. Pendle looks to create the next layer of DeFi on top of these assets, allowing for the tokenization of yield, such that users can trade and hedge based on their risk appetites.

Pendle’s ecosystem allows yield to be “stripped” from the underlying. This mechanism is enabled by separating the yield-generating token into two separate tokens: the Ownership Token (OT) and the Yield Token (YT).

We’ve recently released an introductory piece here which we recommend reading if you’re a newcomer to the Pendle ecosystem!

Pendle ELI5

Buying YT

If yield is speculated to increase, traders can act on this and purchase YT to gain yield exposure. Traders who are long YT benefit when yield increases.

Purchasing YT provides traders exposure to fluctuating rates in a capital-efficient manner as they do not need to purchase and stake the core underlying asset. This can be very powerful as a form of leverage with no liquidation risk that is not currently available. Refer to scenario 1 at the bottom of this article.

YT can also be deposited into Pendle’s liquidity pool to earn LP rewards (trading fees and incentives), adding another layer of yield on top of holding YT.

Selling YT

On the flip side, if yield is speculated to decrease, traders can hedge by selling YT and receiving upfront cash. Users can deposit their yield-generating tokens into Pendle to mint OT and YT. They can then sell YT to hedge against a downturn by capturing the current yield valuation.

This form of yield capture can be thought of as:

1. Earning the future cash flow immediately
2. An interest rate (yield) swap.

Both of these have significant economic implications and are necessary for us to move towards a more mature DeFi market. Refer to scenario 2 at the bottom of this article.

When traders sell YT, they are essentially realizing the current yield, swapping a floating-rate future yield into a fixed-rate present value with an appropriate discount as perceived by the market. The discount/premium of the price of YT compared against the current yield is thus an indicator of:

1. Market sentiment for future yield levels.
2. Market views on time-value in DeFi.

Selling YT also allows for traders to enter a leveraged position on the underlying with no liquidation risk. This is made possible for traders that sell their YT, hold their OT until expiry and then redeem the underlying. Refer to scenario 3 at the bottom of this article.

While we have covered the basic scenarios and use cases with Pendle, there are many more possibilities to be explored, such as arbitraging yields across different yield platforms (such as aUSDC, cUSDC, yvUSDC) and LP yield trading (volatility speculation). We are excited to see the value Pendle brings as DeFi users traverse the yield metaverse and discover unexplored use cases, allowing the unfolding of many aspects on top of yield trading and our AMM.

Scenarios:

The following are 3 scenarios to illustrate the points mentioned above. For the sake of simplicity, we assume no discount rate and fees. In the wild, these factors will come into play in how the market values YT.

Scenario 1 (Bullish yield):

TL;DR: Buying YT = Long yield.

• Assuming an initial capital of $1000 USDT deposited in Aave, a 10% APR in a year would entitle the trader to a yield of $100 in a year. Since we are assuming there is no discount rate, the 1-year YT price should be trading at $0.10.
• If a trader speculates that the APR is going to increase to 20%, the trader can act on this view and purchase 10000 YT-aUSDT (each worth $0.10) with his $1000 capital.
• If the yield does increase to 20%, the trader will earn $1000 ($2000 accrued from YT deducted by initial $1000 capital).
• In contrast, with a $1000 direct deposit into Aave, even if the APY goes up to 50%, the trader would’ve only earned $500 in yield.
• We see that the trader gains more exposure to yield with the same amount of capital. Leverage with no liquidation risk.

Scenario 2 (Hedging against yield):

TL;DR: Selling YT = Hedging yield drawdowns

• Assuming an initial capital of $1000 USDT deposited in Aave, a 30% APY in a year would entitle the trader to a yield of $300 in a year. Assume no discount rate and the 1-year YT price is trading at $0.30.
• If a trader predicts that the APY is going to decrease to 10%, the trader can sell his YT immediately, locking in a guaranteed return of $300 ($0.30 * 1000 YT).
• In the event that the yield does decrease to 10%, the trader will have earned an extra $200 as opposed to not locking in his gains. (holding aUSDT profit → 10%APY * $1000 = $100).

Scenario 3 (Long exposure at a discount):

TL;DR: Selling YT & hold OT until expiry = Purchase underlying at a discount

• Let’s assume $1000 capital is deposited in Compound’s ETH pool with an APY of 40%. Assume no discount rate and the 1-year YT is trading at $0.40.
• The trader deposits the cETH into Pendle, minting YT-cETH and OT-cETH.
• The trader sells the YT immediately and holds the OT until expiry, which can then be redeemed back into the underlying in 1 year.
• Assuming the price of ETH remains the same, after a year, the trader can redeem $1000 worth of ETH having used just $600 of capital. This is equivalent to a leverage of 66% without liquidation risk. ($1000 deposited — $400 sold in YT).
• With Pendle, traders can build a leveraged position (with no liquidation risk) on the underlying asset by selling its YT and holding the corresponding OT until expiry.