Pendle Finance: Efficient Amplification of LRT Capital Efficiency in On-chain Interest Derivatives Market

Pendle Finance
By utilizing a special income tokenization design, Pendle Finance aims to convert future income into derivative products to enable composability in the interest market, providing users with more diversified asset operation strategies. It is in line with the recent trend of yield optimization pursued by the liquidity re-collateralization token (LRT) project, which has led to rapid development of the protocol.
Table of Contents
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Background Introduction of Pendle: LRT Driving New Growth
What Problem Does Pendle Want to Solve: Lack of Composability in DeFi Asset Interests
Building an On-chain Interest Derivatives Market with Pendle
Traditional Interest Derivatives Market: Strip Bonds
Income Tokenization with Pendle Finance
LRT, the Liquidity Re-collateralization Token
Unrealized Point Income Can Also Be Tokenized
Product Architecture of Pendle Finance
Standardization: Tokenizing Tokens into Standardized Yield Tokens (SY)
Decomposition: Splitting Standardized Yield Tokens (SY)
Market: Creating an AMM for Quick Token Exchange
Any Income Can Be Turned into a Market Besides LRT
Pendle Finance was founded in 2021 and completed its seed funding through an Initial DEX Offering (IDO) in the same year. It experienced a long period of silence due to a market downturn, but with the rise of its business and the LST and LRT markets, it has driven Pendle’s growth.
Recommended Reading:
In-depth Analysis of the Liquidity Re-collateralization Token (LRT) Project Opportunities and Risks
Reason for Recommendation: This article provides a contextual review for readers who are not familiar with the re-collateralization field, starting from LST and moving on to LRT, and listing various existing related projects.
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According to DeFiLlama data, Pendle’s Total Value Locked (TVL) has reached $2.8 billion, ranking it as the 13th largest protocol overall, making it an important cornerstone in the DeFi and LST protocols.
(LSDFi dark horse Pendle Finance introduction: Overview of Equilibria and Penpie protocol features in the ecosystem)
In the existing DeFi ecosystem, more and more tokens have native income. For example, stETH issued by Lido or eETH issued by the re-collateralization project Ether.fi will distribute staking rewards to token holders daily.
However, currently, there is a lack of related tools in the existing DeFi environment to obtain more income, short income, or derivatives of future income. Therefore, advanced investors have fewer choices compared to traditional finance.
(Realize the Monetization of Airdrop Points! Whales Market Allows Immediate Trading of Airdrop Points)
Pendle Finance aims to provide investors with more diverse tools to operate investment strategies, with Strip Bonds as the main entry point.
In traditional finance, most bonds combine principal and interest. During the bond holding period, investors receive interest payments and receive the principal back when the bond matures. However, investment products called Strip Bonds emerged, allowing investors to separately purchase principal and interest, providing them with more choices.
Investors who come into contact with Strip Bonds can choose to purchase two types of assets:
Zero-coupon bonds:
Bonds that do not pay interest and can only be redeemed at maturity for the face value of the asset. Because interest is separated, investors can usually purchase them at a discount.
Coupon bonds:
Bonds that can receive interest generated by the corresponding asset and can redeem the current interest on the interest payment date.
Strip Bonds can provide investors with more advanced operations. For example, if a user is optimistic about the long-term returns of an asset, they can choose to purchase more coupon bonds with the same capital.
Investors can use Pendle Finance to bring the concept of Strip Bonds from traditional finance to Web3. They can also purchase zero-coupon assets or income assets, but in Pendle Finance, they are called:
Principal Tokens (PT):
Represent the underlying asset, and after maturity, PT can be redeemed for the target asset in a one-to-one ratio. For example, 1 PT-stETH can be redeemed for 1 ETH worth of stETH.
Yield Tokens (YT):
Can receive the income generated by the target asset. For example, holding 10 YT-stETH allows investors to receive all the income from the 10 ETH deposited in Lido.
In addition to using ETH and USDC to purchase the above tokens, investors can also choose to directly use interest-bearing assets for purchase (such as stETH) and automatically complete the conversion through the protocol’s AMM mechanism.
This allows DeFi investors to have more investment strategies. Investors can choose to purchase discounted principal tokens and redeem the target assets at maturity, resulting in a fixed income from a coin-based perspective.

Purchase Ether.fi Principal Tokens (PT) at a discount
Investors can also choose to purchase a larger number of yield tokens with the same principal, in order to gain more interest income and leverage future income. For example, the current YT for Ether.fi is approximately $287, which means that investors only need to spend $287 to obtain the future income of eETH equivalent to staking one ETH (current price is about $3660).

Purchase Ether.fi Yield Tokens (YT)
In addition to purchasing, investors can also choose to deposit interest-bearing assets into the protocol to obtain both PT and YT, and then buy and sell according to their own strategies.

Deposit eETH to exchange for PT and YT
Pendle Finance aims to create a market for interest derivatives, tokenizing future income and providing composability of income.
The discount rate at which principal tokens sold by Pendle can be obtained reflects the market’s expectation of future interest income.
Because the potential income from points can also be included in the design of income tokens, the popularity of LRT has spread to Pendle. Recently, due to the attention received by the liquidity re-collateralization field, the Pendle team has also incorporated tokens from many LRT projects, amplifying users’ staking income.
Pendle Finance perfectly matches the positioning of LRT products: optimizing asset utilization efficiency.
Because both LRT users and the market prioritize income, Pendle Finance, which can increase income efficiency and composability, naturally becomes an ideal tool for many LRT holders.
In addition, it can be observed that tokens from Puffer Finance or Renzo, these protocols currently do not issue tokens, only points. However, due to market expectations for airdrops, some people are willing to purchase the income tokens of their tokens, thereby creating a market.

One ETH can leverage nearly 27 times the potential Renzo income
So, how does Pendle Finance achieve the design of token separation and income division mentioned above?
First, Pendle Finance packages interest-bearing tokens into a token standard called Standardized Yield Tokens (SY), which allows the protocol to operate with these assets more easily.

All tokens need to be packaged before they can be integrated into Pendle Finance
(Source)
Each SY token is equivalent to the underlying asset on a one-to-one basis and can be unwrapped at any time. They can also be exchanged back to the original asset through Pendle Finance’s AMM.
SY tokens can be automatically split into two types of tokens, namely the aforementioned principal tokens and yield tokens, and the income from the original tokens is automatically given to the holders of the yield tokens.

SY token split into PT and YT
(Source)
For users who do not hold interest-bearing assets and cannot mint Standardized Yield Tokens (SY), or for users who want to withdraw quickly, the Pendle Finance team provides an improved AMM that allows users to exchange PT, YT, and other tokens at any time.
The operation of the Pendle Finance protocol mostly requires the integration of the AMM process. For example, when a user purchases yield tokens with the original asset, the process behind it is to first mint SY tokens, then split them into principal tokens and yield tokens, and then exchange all the principal tokens for yield tokens using the AMM.

Process of purchasing yield tokens from the original tokens in the Pendle protocol
(Source)
According to the Pendle whitepaper, this AMM is an improvement from Notional Finance, and the AMM curve takes into account time and the generated interest rate, narrowing the price range of PT as the expiration date approaches. By concentrating liquidity within a smaller range, capital efficiency is improved.
Recently, due to the popularity of the LSD and LRT markets, combined with the fact that income and capital efficiency are the holy grail of these two areas, Pendle Finance’s business has naturally flourished. It has even been classified as an important protocol in the LRT project, but its applicability is not limited to just liquidity staking income.
Any asset with income potential can be financialized through Pendle Finance.
By integrating with LRT, the market can see the many possibilities that Pendle Finance can actually utilize. It is expected that in the future, whether it is the potential income from airdrops or the income generated by RWAs, which are currently areas where resource exchange is not optimized, Pendle Finance’s story is just beginning.
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Further Reading
LSDFi Dark Horse Pendle Finance Introduction: Overview of Equilibria and Penpie Protocol Features in the Ecosystem
Twitter KOL Launches Coin Trading Challenge, Publicly Records the Process of 2 ETH to 20 ETH Transactions