Key Questions#
- How to calculate the split of SY tokens into PT and YT?
- What do the various values on the Pendle trading interface mean?
- How to profit in Pendle?
- What factors affect the price movement of YT tokens?
How to calculate the split of SY tokens into PT and YT?#
Calculation of PT portion
Example 1: Let's take the example of cDAI generated by depositing DAI into Compound (such interest-bearing assets are encapsulated as SY in Pendle, for more details see EIP-5115)), i.e. cDAI = PT cDAI + YT cDAI.
The price of PT cDAI is determined by the market, but PT cDAI will be cheaper than 1 DAI because it does not include the interest provided by Compound. This means that it is possible to buy 1 PT cDAI for 0.9 DAI, and assume that it can be redeemed for 1 DAI at maturity after one year.
Example 2: In the following image, the price of PT stETH is 0.94 stETH, which implies an APY of approximately 6.4%. Assuming an average stETH yield of 6% over the next year, buying PT stETH locks in a better yield.
The formula SY = PT + YT implies that when PT APY is high, the price of PT shares is low, and consequently, the price of YT is high. In simpler terms, YT purchases the additional portion of the PT price. It is best to express this in terms of the underlying asset.
Calculation of YT portion (emphasis)
In the example of stETH shown in the image below, 1 stETH (YT) is split into 1 PT stETH (0.96 stETH) + 1 YT stETH (0.04 stETH). The income generated by PT is determined at the time of purchase and is 4% APY. When YT stETH is split, its value is 0.04 stETH. If the actual stETH yield over one year is 0.05 stETH, then YT will receive 0.01 stETH (25% yield).
The key factor here is the market's expectation of future yields. If the market prices future yields at 5%, but the actual yield turns out to be 10%, then those who hold YT will profit. The breakeven scenario is when Average future APY = Current underlying APY, which means that the market has accurately priced the yield. Therefore, the core competitive advantage of Pendle's yield gambling is to accurately price the future yields of interest-bearing assets better than the market.
Calculation of actual yield from trading YT stETH
In the image below, 100 YT stETH expiring after one year was purchased on January 1, 2023, for 4.3 stETH. The reason for this trade is the belief that the implied APY of 4.5% is too low and will rise to 5.5%. So, if this prediction is correct, how much money can be made?
By April 1, 2023, the implied APY for stETH has risen to 5.5%, and the underlying APY has increased from 5% at the time of opening to 5.2%. In this scenario, the YT holder gains two types of income: 1) income from selling YT, and 2) interest income from holding YT for 90 days. How should these two types of income be calculated?
- Income from selling YT: In the second image, the price of 1 YT stETH is 0.0393 stETH (considering only the yield in terms of stETH). Therefore, selling 100 YT stETH would yield 3.93 stETH.
- Interest income from underlying asset stETH: Assuming an average annual yield of 5% during the holding period, holding 100 YT is calculated based on a nominal 100 stETH, resulting in in YT yield. If these are all liquidated into stETH at this point, the initial investment of 4.3 stETH can be liquidated into (without considering additional costs such as transaction fees and slippage). This trade realizes a profit of over the 90-day period.
What do the various values on the Pendle trading interface mean?#
The following values appear on the Pendle Market page, each representing a different meaning. It is important to understand how to interpret them.
- Underlying APY: The yield of the underlying interest-bearing asset over the past seven days (expressed as an annualized rate). To trade on Pendle, it is important to have an advantage in predicting this value.
- Implied APY: The implied yield of YT priced by the market. When Implied APY > Underlying APY, it means that the market is pricing future yields higher than the current yield. This value is important as it represents the market's view and pricing.
- Long Yield APY (YT Price): This indicates the yield of holding YT assuming that Implied APY immediately reverts to Underlying APY.
The image below provides an example, where stETH has an underlying APY of approximately 3.66% in Lido, while the market prices PT/YT at 4.12%, indicating that the market expects future yields to increase. Comparing the three different time periods for stETH, the market implies that the average yield will increase within one year but decrease to 3.58% for periods longer than two years, and then slightly increase to 3.8% for periods longer than four years. This suggests that the market believes the long-term stETH yield will be between 3.58% and 3.8%. The 4.12% yield in the red box can be considered a slightly anomalous pricing that reflects the market's rich views on stETH, requiring a fundamental understanding of the ETH Staking industry.
How to profit in Pendle?#
In summary, holding PT in Pendle means taking a bearish position on the future yield of interest-bearing assets. For example, holding PT stETH means believing that the market's pricing of a 4.12% stETH yield will continue to decline. On the other hand, holding YT means taking a bullish position on the future yield of interest-bearing assets. For example, holding YT stETH means believing that the market's pricing of a 4.12% stETH yield will increase.
What factors affect the price movement of YT tokens?#
The image below shows the borrowing rates for various tokens on Compound, such as the Lending Rates for DAI, which represents the yield of cDAI as the underlying asset.
The yield rates for interest-bearing stablecoins on Compound increase during bull markets because lending out stablecoins allows users to continue buying BTC/ETH and increase their exposure for more returns. The yield rates for different tokens are influenced by various factors in different scenarios, which require specific analysis for each case. Here are a few examples of interest-bearing assets in the DeFi space to help understand that accurately predicting the yield rates of interest-bearing assets is a challenging task.
- Staking interest-bearing assets, such as stETH
- Borrowing interest-bearing assets, such as cDAI
- DEX LPs assets, such as ARB-ETH (Camelot)
Using the example of stETH expiring on December 26, 2024, the purpose of trading YT/PT is to obtain additional returns in terms of stETH. First, we need to look at the market pricing, which is determined by one important value, the Implied APY. If we believe that the future APY will be lower than the Implied APY, then buying and holding PT is a better choice. If we believe that the future APY will be higher than the Implied APY, then buying and holding YT is a better choice.
The image below shows the continuous decline in the pricing yield rates on Pendle and the fluctuation in actual yield rates.
To judge the future yield rate of stETH, what knowledge do we need? First, we need to understand the sources of ETH staking income, which can be broadly divided into consensus layer income and execution layer income:
- ETH consensus layer income: The amount of this income is mainly related to the number of validators. As the number of participating validators increases, the rewards from the consensus layer decrease. The image shows the relationship between the number of validators and the consensus layer APR, which can be calculated using the numbers in the Ethereum Model spreadsheet. Currently, there are over 800k validators, and the consensus layer APR is approximately 3.2%.
- ETH execution layer Gas & MEV income: Gas income depends on the transaction activity on Ethereum, which is highly dynamic and difficult to predict. However, we can track it in real-time based on the gas situation. MEV income is even more dynamic and complex. In addition to judging Ethereum transaction activity, it requires an understanding of the bargaining power changes of various roles in the value flow of MEV (as shown in the image). For example, an increase in the bargaining power and income of Searchers and Relayers may mean a decrease in the income of Validators and Stakers (holders of stETH). This is a difficult question for most people to answer.
Based on these factors, we can speculate that as more ETH is staked, the income obtained by stETH from the consensus layer will gradually decrease. If approximately 50% of ETH is staked, the consensus layer yield rate will decrease from the current 3.2% to around 2.1%. The execution layer income is influenced by the transaction activity on Ethereum and is currently between 0.5% and 1.5%. If we believe that more ETH will be staked in the future and there are still many validators in the queue to participate, the yield rate of stETH may continue to decline, making holding PT a better choice. The image shows the continuous decline in pricing yield rates on Pendle and the fluctuation in actual yield rates.
In the case of borrowing interest-bearing assets such as cDAI on the Compound protocol, the income obtained from cDAI comes from the interest paid by other users borrowing DAI. Predicting the yield rate changes of cDAI requires anticipating the supply and demand of DAI on Compound.
Similarly, in the case of DEX LPs assets such as the PENDLE-ETH pool on the Camelot exchange, factors that affect the yield rate include the number of LPs in the pool and the trading volume in the pool.
In conclusion, to profit in Pendle, one needs to have a more accurate ability to predict yield rates than the market in order to identify market mispricing. Before trading, ask yourself, "Do we really have a knowledge advantage over the underlying assets? Are we really respecting the counterparty? Is it worth taking on the contract risks and other costs for the expected excess returns?"