How Pendle Finance works, in a nutshell

Pendle Finance is a “yield-trading” dApp in the decentralized finance ecosystem, that is tremendously useful but not well understood. Back in 2023, I posted a technical explanation of how Pendle works, and today I want to post a simpler example.

A simple bond example

Imagine you can buy a special one-year bond for $1, that pays a variable interest rate—perhaps 4% fixed, plus interest corresponding to the role of a dice, i.e. and additional 1% to 6%.

Now, imagine you could split the “face value” of the bond ($1.00) from its “coupon”, or interest rate (4% + dice roll).

It turns out, you can, and there are people in the markets that are interested in buying just the variable interest component, without having to pay the $1.00 face value.

So now you have this bond with a $1.00 face value, a variable interest rate, and let’s imagine that hypothetically the dice-roll would be 1%. At the end of the year, at “maturity”, you would receive $1.05—i.e. the $1.00 face value, plus the $0.04 fixed component of interest, plus $0.01 for the dice-roll component of interest.

Now let’s imagine there’s a guy willing to pay $0.05 for the variable interest component only, because maybe the dice roll would be 6%, and he’ll get $0.10 at the end of the year, earning himself a 100% return on his investment!

Better yet, let’s imagine there’s 10 guys wanting to buy that variable interest component, and they compete the price up to $0.07.

So you sell them the variable interest component for $0.07, meaning you’ve paid $0.93 for the face value of the bond, which in one year’s time, you can redeem for $1.00, meaning you are guaranteed an interest rate (yield or return) of 7.5% ($0.07/$0.93 = 7.5%)!

So the coupon buyers speculated on the variable interest rate, while you earned a guaranteed return of 7.5%.

That’s how Pendle works!

That’s exactly how Pendle works. Consider the Ethena stablecoin, USDe. If you stake USDe, it becomes the yield-earning token, sUSDe. And that yield is variable, as Ethena captures the interest rates paid on the perpetual futures contracts of ETH and BTC.

So Pendle splits sUSDe into the yield component (YT-sUSDe) and the face-value component (PT-sUSDe).

As more people speculate on the yield, the YT token, you can buy the face-value PT token for a lower price than $1.00. And since that YT token can be redeemed for one USDe at maturity, worth $1.00, you can earn a very high fixed interest rate!

And that’s a simplified explanation for how Pendle works!