1. Research Report Highlights
1.1 Investment Logic and Narrative
Profit from cryptocurrency yield trading can be lucrative, but the actual returns realized by investors are uncertain. This is because the cryptocurrency field is influenced by various factors leading to market fluctuations, making it difficult to predict future yields accurately. Various yield protocols enable investors to profit from future yields, but many established protocols have flaws that could significantly reduce returns. Pendle adopts an improved yield trading approach to optimize investor returns. Pendle envisions becoming the “Uniswap of the interest rate market”.
Key investment points of the project include:
- Large market space: Interest rate swaps dominate the derivatives market, accounting for 80% of the derivatives track, with interest rate swaps comprising 80% of that, resulting in massive trading volumes. However, this track has just been introduced by Pendle on-chain, still in its very early stages.
- Pendle’s overall data performance is impressive, with its trading volume, TVL (Total Value Locked), and token price, all reaching historical highs.
- Institutional demand in the Staking track is inevitable, whether it be banks, hedge funds, mutual funds, ETF issuers, or ETF brokers, all of whom have a need to hedge interest rate risks.
- Pendle’s v3 version will introduce the traditional interest rate swap track onto the chain, targeting a market size in the trillions, and we are looking forward to Pendle’s performance in this regard.
- Pendle currently relies on the development of the LRT (Long-Range Transport) track. The overall LRT track still has multiple levels of growth potential, and although most of Pendle’s obligations currently rely on LRT, there is an opportunity in the future to gradually reduce the proportion of LRT, as it is essentially aimed at the entire market of interest rate swap track, which requires institutional participation to help diversify its assets.
1.2 Valuation Explanation
In TradeFi, interest rate derivatives occupy the majority position in the derivatives market. Furthermore, with the development of TradeFi, the overall size of the derivatives market is gradually increasing. As of June 2023, the total position in the derivatives market reached $71.47 trillion, with outstanding positions in interest rate derivatives reaching $57.37 trillion, accounting for 80.2% of the share.
On-chain interest rates are still in the very early stages of the derivatives track, and with the influx of collateral into TradeFi, demand in this area is expected to explode.
Currently, the price of Pendle has surpassed its previous high, and there may no longer be limitations on its growth potential. Its main underlying supported token is LRT. If the total market value of LRT is currently $5.7 billion, and the TVL (Total Value Locked) flowing into Pendle is $2.37 billion, including two major tokens, EETH (ether.fi) and WETH.
If the overall TVL of the LRT project increases fivefold, then Pendle’s TVL will also have the potential to increase fivefold. With the introduction of the traditional interest rate market in 2024 and TradeFi’s entry, the demand for Pendle’s smooth yield curve and risk hedging will be higher. As a result, the upside potential of the project will be even greater.
1.3 Key Risks
- Smart contract risk: Despite Pendle undergoing audits by multiple auditing firms, there remains the possibility of vulnerabilities in the smart contracts leading to potential loss of funds.
- Failure of ETH spot ETF approval: If the ETH spot ETF fails to gain approval, it may have significant implications for the overall staking market in the future of TradeFi.
- Exposure to extreme market conditions: Pendle may face unknown risks during extreme market conditions.
- Dependency on LRT: Pendle is currently heavily reliant on LRT, and failure to effectively expand its business scope may lead to a single risk exposure.
- Liquidity risk: Due to the multitude of token types, there may be insufficient liquidity for long-tail assets, resulting in liquidity concentration issues. This could fail to meet the diverse arbitrage needs of some institutions, but this is a long-term issue.
2. Project Overview
2.1 Business Scope
Pendle is a blockchain project focused on the tokenization of yield rates. Through its platform, users can lock in the future yield of their crypto assets and receive profits in advance. This innovative approach not only provides cryptocurrency holders with a new source of income but also introduces more liquidity and flexibility to the interest rate market. Pendle achieves this functionality through smart contract technology, allowing users to participate in the market in a decentralized and secure manner.
2.2 Founding Team
Pendle was founded in 2021, with team members based in Singapore and Vietnam. Currently, the team consists of approximately 20 individuals registered on LinkedIn.
TN Lee (X: @tn_pendle): Co-Founder, Previously was a founding team member and business lead at Kyber Network. Afterward joined a mining company called RockMiner, which operates approximately five mining farms. In 2019 Dana Labs founded, primarily focusing on customized FPGA semiconductor solutions.
Vu Nguyen (X: @gabavineb): Co-Founder, previously served as the Chief Technology Officer (CTO) at Digix DAO, specializing in tokenizing real-world assets (RWAs) projects. Together with TN Lee co-founded Pendle.
Long Vuong Hoang（(X: @unclegrandpa925): serves as an Engineering Manager, holding a Bachelor’s degree in Computer Science from the National University of Singapore. In January 2020, joined the National University of Singapore as a teaching assistant, followed by an internship as a software engineering intern at Jump Trading in May 2021. Joined Pendle as a Smart Contract Engineer in January 2021 and was promoted to Engineering Manager in December 2022.
Ken Chia（X: @imkenchia): serves as the Institutional Relations Manager, holding a Bachelor’s degree from Monash University. Previously interned in investment banking at CIMB, Malaysia’s second-largest bank, and later worked as an Asset Planning Specialist in private banking at J.P. Morgan. In 2018 entered the Web3 space and served as the COO at an exchange. In April 2023, joined Pendle as the Institutional Relations Manager, overseeing institutional markets such as proprietary trading firms, cryptocurrency funds, DAO/protocol treasuries, and family offices.
2.3 Investment Backgrounds
The project’s main investors include Mechanism Capital, HashKey, Bixin Ventures, and Binance Labs.
Currently, investors that can be found on-chain include Spartan, Arthur Hayes, Hashkey, Alliance DAO, FalconX, and others.
2.4 Project Development Roadmap
According to a tweet by co-founder Vu Nguyen, Pendle’s V3 version is planned to be launched in 2024. It will include traditional financial interest rate derivatives, which will generate significant interest in tradeFi. Specific implementation details are currently unknown.
3. Product and Business Situation
3.1 Official Website Data (as of February 2024)
3.2 Social Media Data
3.3 Community Data
4. Project Analysis
4.1 Code
The code of the product has been audited by multiple auditing firms.
Its project code development remains at a normal level, and the development team also remains stable.
4.2 Product
Pendle is a permissionless yield farming protocol where users can execute various yield-generating strategies. The functioning of Pendle primarily revolves around three components: Yield Tokenization, Pendle AMM, and VePendle, as detailed below:
Yield Tokenization
Pendle innovatively tokenizes yield-generating assets into SY tokens, based on the ERC-5115: SY Token standard. For example, stETH is wrapped into SY-stETH, which is then divided into its principal and yield components, represented by PT (Principal Token) and YT (Yield Token) respectively.
- PT tokens do not accrue any yield but can be redeemed for the underlying asset at a 1:1 ratio upon maturity.
- PT is similar to PO (Principal Only) securities or zero-coupon bonds in TradFi.
- Yield tokens represent the yield accrued by the asset until the maturity date.
- YT is similar to IO (Interest Only) securities in TradFi.
Pendle AMM
Both PT and YT can be traded through Pendle’s AMM, which serves as Pendle’s core engine. On Layer2, the project utilizes the Redstone oracle. Pendle’s AMM enables efficient DeFi yield trading: traders looking to earn fixed income purchase PT, while those looking to long the yield purchase YT. The process for purchasing yield tokens YT for a specific period is as follows:
The process for selling YT tokens is as follows:
SY serves as an intermediary asset for the SWAP pools, so LP providers need to supply YT-SY / PT-SY token pairs. SY represents a standardized yield token that can cover a wider range of asset classes. This standardization increases attractiveness to investors as it provides more flexibility and the possibility to access more assets, potentially attracting more participants and providing higher liquidity. Therefore, choosing SY as the intermediary asset for LP pools offers these advantages.
Liquidity providers can earn income from the following sources:
- Swap fees generated by the pool
- PENDLE incentives
- Protocol incentives from underlying assets (e.g., $COMP, $AAVE)
In Pendle, the separation of the yield portion (YT) and principal portion (PT) of assets allows investors to independently trade and manage these two components, bringing about some unique pricing and value dynamics:
- Separation of future yield: When you purchase PT, you are essentially forfeiting any potential yield generated during the holding period because this portion of the yield has already been tokenized through YT and may have been purchased by others. Therefore, the price of PT reflects this lack of yield, typically purchased at a discount to the full value of the underlying asset. However, we agree on a time frame, meaning YT can only reflect the yield situation for a certain period of time.
- Time value and risk considerations: Investors purchasing discounted PT do so with the expectation that they are buying at a lower price now, anticipating that its value will increase in the future, especially at a specific point such as maturity, approaching or equaling the value of the underlying asset. This expectation takes into account the impact of time value and the risk of holding PT until redemption.
Assuming a simplified example to illustrate how PT (Principal Token) eventually returns to the price of its underlying asset (ST):
Conditions:
- Underlying Asset (ST): A bond with a current market value of $100, an annual interest rate of 5%, and one year until maturity.
- Initial Price of PT: Let’s assume that due to the separation of future one-year income (i.e., the YT portion), the initial trading price of PT is $95.
Process:
- Income Separation: On the Pendle platform, the holder of this bond decides to separate its income and principal, creating PT and YT. Since YT represents the right to future income, the price of PT will be lower than the full price of the original bond (ST), reflecting the lost future income value.
- Passage of Time: As time passes, the bond approaches its maturity date. Because YT already represents all expected income during that period, the value of PT essentially represents the principal recovery that can be obtained from the bond at maturity.
- Value Recovery: As the maturity date approaches, the market value of PT gradually rises because market participants expect PT holders to redeem PT at maturity for an amount equivalent to the value of the underlying asset (i.e., the bond principal). If the face value of the bond is $100, then theoretically, the price of PT should gradually rise to $100.
Result:
At maturity, PT holders can use PT to redeem the bond principal worth $100. Therefore, even though PT initially traded at a discounted price (e.g., $95), with the passage of time and approaching maturity, its value will gradually increase, eventually returning to the full value of the underlying asset, which is $100.
In trading, participants are speculating or hedging future yield rates. Selling YT smooths the future yield curve, allows for early redemption, or bets on a decrease in future yield rates. Buying YT indicates a bullish view on future yield rates. Buying PT allows for discounted purchasing to some extent and implies a bearish view on the yield rate during that period.
VePendle
Bringing the TradeFi interest rate derivatives market onto the chain, accessible to everyone, VePendle serves as the governance system for Pendle:
- The longer you lock PENDLE, the greater your corresponding VePendle value.
- VePendle value decays over time, but you can extend your lock duration to offset the decay.
- The more VePendle you own, the greater your voting power. After voting for a pool, you’re entitled to 80% of the swap fees collected by that pool.
- VePendle holders also receive a portion of protocol revenue derived from swap fees and YT fees.
4.3 Ecological Development and Data Analysis
Currently, the project ecosystem includes:
Penpie: Penpie is a DEFI platform launched by MagPie, providing users of the Pendle platform with yield and vePendle incentive services.
Equilibria: Converts idle PENDLE into ePENDLE and earns yield by staking through the ePENDLE treasury.
The graph above tracks the PNP and EQB locked in Penpie and Equilibria, as well as their ownership of the Pendle governance token (vePendle). This demonstrates the level of control that vlPNP and vlEQB holders have over the Pendle protocol. vlPNP and vlEQB holders guide the allocation of vePendle in governance proposals and weighted voting measures.
Penpie holds approximately 12 million vePendle tokens, while Equilibria holds approximately 7.7 million vePendle tokens. Currently, there are a total of 32.7 million vePendle tokens. Therefore, Penpie holds approximately 36.7% of the governance power in Pendle, and Equilibria holds approximately 23.5% of the governance power in Pendle (data as of March 2024).
The number of transactions and trading volume on the Pendle protocol has been steadily increasing, indicating a growing demand for interest rate derivatives in the market, fueled by the development of projects such as LSD, LSDFI, LRT, Restaking, and other DeFi initiatives. As of March 7, 2024, the cumulative trading volume has surpassed $4 billion, and the trend is showing a gradual increase.
In terms of TVL, the project has its own Automated Market Maker (AMM) pools, supporting the exchange of various SY, PT, and YT tokens. Currently, both from a coin-based and a stablecoin-based perspective, the TVL is gradually increasing.
https://cointelegraph.com/news/ark-21shares-refiles-ethereum-etf-cash-creates-staking
With the assistance of Staking development, there is an expectation that demand for the project will gradually increase, especially with the potential entry of institutions. Many institutions have begun to mention the issue of Ethereum staking rewards, and they generally believe that after the approval of spot ETFs, TradeFi will be able to earn on-chain yield from staking ETH while also charging custody fees to depositors.
Therefore, there will be significant demand for products like Pendle’s interest rate swaps, and due to its dominant position in the interest rate space, the natural progression of introducing traditional interest rates to the chain will occur in the future. This will enable institutions to operate interest rate derivatives on-chain, potentially unlocking trillions of dollars in trading volume.
The liquidity in Pendle’s pools is also gradually increasing at present.
Among all the pools, the main projects are in the LRT track. With the issuance of coins for LRT track projects and the continued popularity of the future Staking track, this track will become a popular focus in the industry, and its growth rate will also be relatively high. Currently, the TVL of the main LRT track is in the growth stage, which has a very direct promoting effect on the Pnedle of the main pool, LRT.
4.4 Track Scale and Potential
Interest rate derivatives (IDRs) are among the highest-traded segments in the derivatives market. Derivatives are securities whose value is derived from one or more underlying assets. Their value is determined by the fluctuations of the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates, and market indices.
In TradeFi, interest rate derivatives occupy a significant portion of the market position in the derivatives market. Moreover, with the development of TradeFi, the overall size of the derivatives market is gradually increasing. As of June 2023, the total position in the derivatives market has reached $714.7 trillion, with outstanding positions in interest rate derivatives reaching $573.7 trillion, accounting for 80.2% of the market share.
In the realm of interest rate derivatives (IDRs), there are three major subcategories: interest rate swaps (Swaps), forward rate agreements (FRAs), options, and other tools. Among traditional IDRs, interest rate swaps account for approximately 81.2% of the market share.
In TradeFi, the market for interest rate swaps is primarily dominated by institutions, and the trading volume is significant. Interest rate swaps are financial derivatives that allow two parties to exchange their respective interest payment obligations. This exchange typically involves swapping fixed-rate and floating-rate interest payments. Interest rate swaps are widely used in financial markets, with major participants including:
- Banks and financial institutions: Banks use interest rate swaps to manage interest rate risk, adjust the interest rate structure of their balance sheets, and optimize capital utilization. Financial institutions also utilize them for arbitrage and risk hedging purposes.
- Corporations: Corporations use interest rate swaps to hedge against changes in borrowing costs. For example, if a company anticipates that interest rates will rise in the future, it may lock in its interest expenses by entering into a swap contract where it pays a fixed interest rate and receives a floating interest rate.
- Investors and hedge funds: They use interest rate swaps as an investment tool or risk management strategy to seek profits by predicting changes in interest rates or to hedge against interest rate risks in other investments.
- Governments and public institutions: These entities may use interest rate swaps to manage the cost and risk of their debt portfolios. Through swaps, they can more efficiently match funding needs and debt service costs while reducing the impact of interest rate fluctuations.
- Central banks: Although not a common practice, central banks may participate in the interest rate swap market in specific circumstances to influence short-term interest rates as part of their monetary policy.
In the traditional financial world, interest rate derivatives are the largest category of derivative trading, with interest rate swaps accounting for 82% of the overall interest rate derivatives market. However, in the world of blockchain, interest rate swaps are still in a very early stage. Pendle, as a leading project, specializes in on-chain interest rate swaps specifically for Ethereum.
With the entry of traditional financial institutions, especially the attention from institutions like Grayscale, JPMorgan Chase, and BlackRock to the Ethereum staking market, this can provide TradeFi with extensive arbitrage opportunities. This could be of significant importance for investments in Pendle given the current context.
Currently, the supported assets for yield tokenization and their market values are as follows:
- Ethereum Staked Tokens (e.g., wstETH): Currently, approximately 26% of ETH is staked, meaning all of these tokens can be tokenized. The total value locked (TVL) in the Liquidity Staking Derivative (LSD) space is currently around $597 billion.
- Tokens representing positions in lending protocols (e.g., Compound or Aave): Tokens like cDAI, representing DAI deposited in Compound, have their own annualized yield rates. This segment offers a stable and extensive market space for generating yield. The TVL in lending protocols is approximately $343 billion.
- LP Tokens (e.g., GLP in GMX): LP tokens in various DeFi projects offer their own interest rates when staked. Nearly all DeFi projects have LP token rewards.
- Liquidity Re-Staking Tokens (LRT) and Restaking Tokens: For example, EigenLayer and Renzo Finance, with a combined TVL of $170 billion as of now.
Overall, the potential for this segment is exceptionally high, and with the gradual entry of traditional institutions, the demand for Pendle is expected to strengthen gradually.
Potential use cases for institutions include:
- Fixed income, such as earning fixed income on stETH.
- Long yield rate, for example, betting on the increase in stETH yield rate by purchasing more yield rates.
- Earning more yield without additional risk, for example, providing liquidity with your stETH.
For example, in the Restaking market of EigenLayer, as the number of EigenLayer depositors increases, the future yield rate is likely to decline. Therefore, in the current high-yield environment, one can choose to sell YT and cash in on the high APY. In the eyes of institutions, they can also lock in the stETH staking yield to hedge against potential yield rate decreases caused by declining on-chain activity.
5. Tokens
5.1 Total Supply and Circulating Supply
As of March 7, 2024, according to Coingecko statistics, the total token supply is 258,446,028 tokens, with a circulating supply of 96,950,723 tokens. The current market capitalization is $298 million, and the fully diluted valuation (FDV) is $790 million. Liquidity incentives account for 49.3% of the total tokens, while the team currently holds 17.7%, and investors hold 12.1%.
The liquidity incentives are expected to continue until the end of 2030, with an official assumption of a 2% annual inflation rate decreasing by 1.1% weekly until April 2026. According to the release schedule, it is anticipated that approximately 270 million tokens will be in circulation around May 1, 2025, with overall minimal growth, having little impact on the token price during bullish market conditions.
5.2 Tokenomics
Pendle’s token, known as vePendle, primarily serves governance custody purposes. Through the utilization of vePendle, Pendle token holders can access a range of features aimed at enhancing token utility.
The value of vePendle is directly proportional to the amount of Pendle staked and the duration of the stake. The vePendle value will decay over time. vePendle holders vote and channel rewards to different pools, effectively incentivizing liquidity in the pools they vote for.
Pendle charges a 3% fee on all yields generated from YT. Currently, 100% of this fee is allocated to vePendle holders, while the protocol does not collect any revenue. In addition to this, vePendle voters also have the right to receive 80% of the interest swap fees from the voting pool, which constitutes the voters’ APY. The chart above represents the latest voting situation, with the crvUSD pool holding approximately 44% of the voting power concentrated in this pool. As of March 7, 2024, a total of 49.52 million tokens are locked in Pendle, with vePendle serving as a virtual token of voting rights and privileges, totaling 32.76 million tokens, with an average lock duration of 421 days.
5.3 Market Performance and Window Period Forecasting
The main liquidity pool on Pendle currently focuses on LRT (Liquidity Reassignment Tokens) projects. Let’s analyze primarily based on LRT projects.
The above are tokens belonging to the LRT category, which are based on Restaking and LSD tokens. The market space for Restaking is currently at $11 billion, while LSD stands at $551 billion. These figures are influenced by factors such as the price of ETH, the development of the LSD sector, and the increasing involvement of mainstream financial institutions in staking. Consequently, the market space becomes more extensive.
In the current scenario, LRT tokens have a market space of $660 billion. This represents significant market growth potential for Pendle, particularly within the LRT sector. Additionally, Pendle accepts tokens that generate yield, such as those from Compound. Moreover, the introduction of off-chain interest rate swap products, known as Pendle v3, is expected later this year.
Based on the current upward trend in coin price, it aligns with the development trend of the Staking sector. Currently, the coin price has reached an all-time high, but its market capitalization is only $300 million (with a coin price of $3.11), with a total circulating supply of approximately $800 million. However, due to the release mechanism issue, the fully diluted valuation (FDV) is estimated to be only $300 million by May 2025. Therefore, we believe that the token may have significant upside potential.
5.4 Profitability Expectation Assessment:
Pendle’s coin price has already surpassed its previous high, indicating that its growth potential may no longer be limited. Currently, its main underlying supported tokens are LRT. If the overall market value of LRT is $5.7 billion and the TVL flowing into Pendle is $2.37 billion, including EETH (ether.fi) and WETH, two major tokens, there is substantial potential for profit.
If the overall TVL of the LRT project increases fivefold, then Pendle’s TVL will also have the potential to increase fivefold. With the introduction of the traditional interest rate market in 2024 and the entry of TradeFi, the demand for Pendle to smooth yield curves and hedge risks will increase. This will likely lead to even greater upside potential for the project.
6. Value assessment
The project is in a mature stage, but the team is still improving its economic model and enhancing liquidity while exploring the possibility of introducing traditional finance’s interest rate swaps. We believe it has the potential to become the Uniswap of the interest rate derivatives space, a market with much greater potential than the spot market due to the participation of institutional investors and its significantly larger trading volume.
Its competitive advantage lies in being the leader in on-chain interest rate derivatives and having its own ecosystem, currently enjoying an absolute monopoly position in this space, which is still in its very early stages.
Looking at the medium to long term, not only will the on-chain spot market flourish, but the staking and restaking sectors will also experience rapid growth. With institutions showing interest in TradeFi, the on-chain derivatives market is poised for rapid expansion, with Pendle being the only current unique choice available.
7. Summary
Pendle is a blockchain project that focuses on tokenizing yields, allowing users to lock in the future yields of their crypto assets and receive them in advance. This innovative approach not only provides cryptocurrency holders with a new source of income but also introduces more liquidity and flexibility to the interest rate market. Pendle achieves this functionality through smart contract technology, enabling users to participate in the market in a decentralized and secure manner.
Pendle’s investment highlights include:
- The market space is significant, with interest rate swaps being the primary derivative market dominated by institutions. Interest rate derivatives occupy 80% of the derivative market space, with interest rate swaps accounting for 80% of that. The trading volume is immense, but in the on-chain space, this market segment has only recently been introduced by Pendle, still in its early stages.
- Pendle’s overall performance data is impressive, with its trading volume, Total Value Locked (TVL), and token price all hitting new all-time highs.
- There is a trend of traditional institutions entering the staking space, including banks, hedge funds, mutual funds, ETF issuers, or ETF brokers, all of which have a demand for hedging interest rate risks.
- The V3 version will introduce the traditional interest rate swaps market onto the blockchain, targeting a market worth trillions of dollars. We look forward to Pendle’s performance in this regard.
Although Pendle currently relies on the development of the LRT track, the LRT track alone still has the potential for exponential growth. Additionally, Pendle has the opportunity to gradually reduce its reliance on LRT in the future because it is essentially geared towards the entire market of interest rate swaps. This requires institutional involvement to help diversify its assets, which also implies a strong mutual dependency between Pendle and institutions. Therefore, Pendle is a valuable investment target, and investors are advised to pay close attention.
Note: All of the above opinions are not investment advice. If there are any inappropriate points, please feel free to leave a message to correct them.
The research report was completed in early March 2024 and revised in early April 2024. The main references and data sources are as follows:
《KEY TRENDS IN THE SIZE AND COMPOSITION OF OTC DERIVATIVES MARKETS IN THE FIRST HALF OF 2023》
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