Pendle Finance, an on-chain interest derivative market, perfectly amplifies the capital efficiency of LRT.

The Principal Interest Separation Protocol by Pendle Finance utilizes a unique income tokenization design to convert future income into derivative products, enabling composability in the interest market and providing users with a more diverse asset operation strategy. Aligned with the recent project of Liquidity Reinvestment Token (LRT) that focuses on optimizing returns, the protocol has seen rapid development.

Pendle Background: LRT Driving New Growth

Pendle Finance was founded in 2021 and completed seed funding through an IDO in the same year. There was a long period of silence in between due to market downturns, but with the rise of business and LST, LRT markets, Pendle's growth has been propelled.

According to DeFiLlama data, Pendle's Total Value Locked (TVL) has reached $2.8 billion, ranking it as the 13th largest protocol, solidifying its position as a key player in the DeFi and LST protocols.

LSDFi Dark Horse Pendle Finance Introduction: An Overview of the Equilibria and Penpie Protocols in the Ecosystem

Issues Pendle Aims to Solve: Lack of Composability in DeFi Asset Yields

In the current DeFi ecosystem, more and more tokens come with native yields. For example, tokens like stETH from Lido or eETH from Ether.fi that offer daily staking rewards to token holders.

However, the current DeFi environment lacks tools for investors to earn more, short yields, or derivative future yields, limiting advanced investment options compared to traditional finance.

Airdrop points can be monetized! Whales Market allows immediate trading of airdrop points

Pendle Finance aims to provide investors with more diverse tools to execute investment strategies, with Strip Bond as the primary entry point for these tools.

Pendle Building an On-Chain Interest Derivatives Market

Traditional Interest Derivatives Market: Strip Bonds

In traditional finance, most bonds combine principal and interest. During the bond holding period, investors receive interest payments and receive the principal back at maturity. However, the introduction of investment products that separate principal and interest—Strip Bonds—provides investors with more choices.

Investors can choose to purchase two types of assets with Strip Bonds:

• Zero-coupon bonds: Bonds that do not pay interest and can only be redeemed at face value on the maturity date. Investors can usually purchase them at a discount due to the separation of interest.
• Bond Coupon: Bonds that generate interest based on the corresponding asset and pay the interest at the bond's interest payment date.

Strip Bonds offer more advanced investment options for investors. For example, if a user believes in the long-term returns of an asset, they can choose to purchase more bond coupons with the same capital.

Pendle Finance Yield Tokenization

Investors can use Pendle Finance to bring the concept of traditional finance's principal and interest separation bonds into Web3, where they can purchase zero-interest assets or yield-generating assets, renamed as:

• Principal Token, PT: Represents the underlying asset, and upon maturity, PT can be redeemed for the underlying asset at a one-to-one ratio. For example, 1 PT-stETH can be redeemed for 1 ETH's stETH value.
• Yield Token, YT: Allows investors to receive the yield generated by the underlying asset. For instance, holding 10 YT-stETH tokens enables investors to receive all the ETH yield from staking in Lido.

Aside from using ETH or USDC to purchase the tokens mentioned above, investors can also directly use interest-generating assets like stETH to buy tokens and automatically convert them through the protocol's AMM mechanism.

This enables DeFi investors to have more investment strategies. Investors can choose to purchase discounted principal tokens and redeem the underlying asset upon maturity, which provides a fixed return in terms of the base currency.

Alternatively, investors can choose to purchase a larger quantity of yield tokens with the same principal to earn more interest, leveraging future returns. For example, the current price of Ether.fi's YT is around $287, meaning users can acquire future eETH returns equivalent to staking one ETH, which is currently priced at about $3660, by spending only $287.

Aside from purchasing, investors can also choose to stake interest-generating assets in the protocol to receive both PT and YT and then trade based on their strategy.

Pendle Finance creates a market for interest derivative products, tokenizing future returns to provide composability in yields.

By observing the discount rate of principal tokens sold by Pendle, one can gauge the market's expectations for interest income.

Liquidity Re-Staking Token LRT

Due to the potential returns from staking being included in the design of yield tokens, the LRT craze has reached Pendle. Recently, as the liquidity re-staking field gains market attention, the Pendle team has also integrated many LRT project tokens to enhance users' staking returns.

Pendle Finance can perfectly align with LRT product positioning: optimizing asset utilization efficiency.

Since LRT users and the market are primarily yield-focused, Pendle Finance, which amplifies funds' efficiency and composability in returns, naturally becomes an ideal tool for many LRT holders.

Current supported LRT projects include: Zircuit ezETH, Bedrock uniETH, Swell rswETH, Renzo ezETH, Kelp rsETH, Ether.fi eETH.

Unrealized Point Returns Can Also Be Tokenized

Additionally, tokens from protocols like Puffer Finance or Renzo, which currently do not issue tokens but have points, are still purchased by individuals due to expectations of airdrops. This creates a market for the tokens' yield tokens, and even a dedicated page for point projects is set up here.

Pendle Finance Product Architecture

So how does Pendle Finance achieve the token segmentation and yield design described above?

Standardization: Minting Tokens as Standardized Yield Tokens SY

Firstly, Pendle Finance packages interest-generating tokens to provide a standard for minting standardized yield tokens (SY) to facilitate protocol operations on these assets.

Each SY token is equivalent to the native asset and can be unwrapped at any time or exchanged back to the original asset through Pendle Finance's AMM.

Decomposition: Splitting Standardized Yield Tokens SY

SY tokens can be automatically split by the system into two tokens: the principal token and the yield token mentioned above, with the original token's income automatically allocated to yield token holders.

Market: Establishing an AMM for Quick Token Swaps

For users without interest-generating assets, unable to mint standardized yield tokens (SY), or those looking for quick withdrawals, the Pendle Finance team offers an enhanced AMM that allows users to swap PT, YT, and other tokens at any time.

Most of Pendle Finance's protocol operations rely on AMM integration processes. For instance, when users purchase yield tokens using the original asset, the process involves minting SY tokens, splitting them into principal and yield tokens, and then exchanging all principal tokens for yield tokens through AMM.

According to the Pendle whitepaper, this AMM is an enhancement of Notional Finance, where the AMM curve considers time and yield rate, narrowing the price range of PT as it approaches maturity. This increases capital efficiency by concentrating liquidity within a smaller range.

Beyond LRT, Any Yield Can Be Marketized

Due to the recent popularity of LSD and LRT markets, coupled with the inherent focus on yield and capital efficiency in these areas, Pendle Finance's operations have naturally flourished. It has even been classified as a significant protocol in LRT projects. However, its application extends beyond liquidity staking returns.

Any asset with yield can be financialized through Pendle Finance.

By combining with LRT, the market sees more possibilities that Pendle Finance can practically utilize. Expectations are that areas like potential airdrops of points or income generated by RWAs, which are currently unoptimized resource exchange fields, may just be the beginning of Pendle Finance's story.