This article is for informational purposes only and not a promotion for any project mentioned therein.
I stumbled on a very interesting DeFi product that brings a rather fresh solution to investing in yield-bearing assets.
I'll admit, it was a bit confusing at first as the use of the word “future” made me instantly think that this was a leveraged derivative solution(as in futures or perpetual contracts in their original sense) in respect to yields, but on a deeper look, this is not exactly as a futures contract, but it presents some level of leverage and in fact includes buying a derivative.
To ensure that it's easy for native to Hive readers to easily understand this, I'm going to use Hive-based assets to explain.
But first, what's Pendle generally?
Pendle is a yield management protocol that lets users get more from yield-bearing assets by separating them into different parts and letting users speculate on the changes in the underlying yield. — Coingecko
Pendle Finance is a decentralized protocol focused on yield tokenization. It offers users the ability to separate yield-bearing assets into principal (PT) and yield (YT) tokens. This design allows users to trade future yield as a standalone asset, providing options to lock in fixed returns or speculate on variable yields. — Datawallet.com
Pendle Finance is an innovative DeFi protocol specializing in yield tokenization and trading. It introduces a novel framework allowing users to tokenize and trade future yields of yield-generating assets, effectively creating a market for interest rates in the DeFi space. By enabling the separation and trading of yield and principal components of an asset, Pendle unlocks new possibilities for yield optimization, risk management, and speculative opportunities within the DeFi ecosystem. - Coinbureau
If you're highly exposed to traditional finance, you might think of something like “Interest Rate Swaps(IRS)” when you read the above but unlike IRS, what Pendle offers requires locked-in principal, whereas IRS is just based on a notional value( made up essentially) — classic TradeFi reality amirite?
What it means to tokenize and trade yields
Having recently written a piece on yield farming being improved by integrated stablecoins on blockchains and protocol economies, stumbling on Pendle brings fresh ideas on how a third solution can be deployed to make DeFi much more stable, but of course, that will be in a separate article.
Moving on, what do we mean by tokenizing yield and trading them? I'm going to use Hive and HBD to explain this to keep it simple. But keep in mind that to trade a future yield, the underlying asset has to be locked and derivatives that represent the principal asset and the yield are created to enable stakers to sell the yield while maintaining ownership of the principal asset and buyers of yield do not need exposure to the principal but only the yield itself.
Hive is a yield-bearing asset when staked or powered up into HP. HBD is also a yield bearing token, though a stablecoin, it yields 15% over a year through HBD savings.
Now imagine if you could get all your yield paid to you immediately or if you're not a stakeholder and want the yields generated on Hive or HBD without significant investment, you could buy the future yield before it is even earned.
Certainly, you may want to ask, why would you want to buy or sell the yield?
Yields are generally not stable, and to get yields, you generally have to first acquire the principal assets. To eliminate huge exposure to the underlying asset, as a buyer of yield, you get access to the future yield at a discount if yield increases overtime without much financial exposure and for sellers, you gain access to your yield immediately and can do whatever you want with it.
The thing is, most sellers will either expect yield to fall or simply need the yield immediately and yield buyers simply don't want a huge financial exposure but still want the yield which they expect to rise.
Just a year ago, if I'm not mistaken, HBD’s interest was at 20%, and today it's 15%. If you sold the HBD yield as a position holder, you'd have avoided the 5% drop as the buyer would have paid for it.
But of course, HBD’s yield being determined by witnesses makes it not the best token to deploy this on. However, Hive's token yield is more flexible and influenced by far more, e.g curation frequency. Make no mistake though, this also introduces a risk for yield buyers, unless they somehow control the curation activities within said accounts.
Looking beyond these flaws and focusing on more automated factors that influence yield, this solution makes for a great way for DeFi stakeholders to access capital(from yields) without waiting long periods or selling their assets and for speculators to gain exposure to high yield positions without taking huge financial risks.
Think about how much you need to spend buying Hive to earn 10,000+ Hive yearly. Tokenizing yield and making them tradable enables you to gain access to the yield without the full capital required to earn it directly.
That said, staying profitable will involve making your personal analysis of what % return you'd get from directly spending the amount you'd pay for a future yield on acquiring an actual position with its own yield.
That is, if you expect, for instance, a profit of 1.4%(additional yield) on a future yield(that's currently 3%) that costs $10,000, you're better off just buying a $10,000 position and earning the 3% as that's more profitable.
However, buying the future yield becomes very profitable(and lower risk) if it is paid in a stablecoin and you expect the price of the underlying asset to crash while the yield increases.
This is something I'll be exploring in a later article.
And that's a wrap, you can visit Pendle.finance to learn how it works more deeply with assets like stETH. Remember, this is not financial advice and I have no exposure to Pendle or ETH.