In traditional finance, interest rate swaps are among the most critical derivative instruments, enabling investors to hedge against or speculate on interest rate movements. This mechanism enhances market efficiency and contributes to overall financial stability. According to the Bank for International Settlements (BIS), the notional value of interest rate swaps reached **$490 trillion in 2022**—approximately **35 times larger** than the total annual trading volume of the entire cryptocurrency market, which stood at around $14.05 trillion that year.
Enter Pendle Finance (AW#20), a rare DeFi protocol dedicated to interest rate swaps that emerged after the 2020 DeFi Summer. After launching its V1 in late 2021, Pendle achieved a peak Total Value Locked (TVL) of nearly $40 million. However, as the crypto market cooled into a bear phase, the protocol gradually faded from mainstream attention.
By the end of 2022, Pendle launched V2, reigniting interest amid growing demand for yield-based financial instruments. As of July 9, 2023, its TVL surged to approximately $135 million, marking Pendle as one of the most innovative and representative next-generation DeFi protocols. In this article, we’ll explore Pendle’s core mechanics, the transformative upgrades in V2, and insights from an exclusive conversation with co-founder TN Lee, revealing how Pendle evolved from near obscurity to a cornerstone of yield trading in DeFi.
How Pendle Enables Interest Rate Swaps
At its core, Pendle allows users to tokenize future yield from yield-bearing assets—such as staked ETH (stETH)—by splitting them into two distinct tokens:
- Principal Token (PT): Represents the principal amount, redeemable at maturity.
- Yield Token (YT): Captures all future yield generated until maturity.
To illustrate, consider stETH issued by Lido. As Ethereum transitioned to Proof-of-Stake, stETH accrues value through staking rewards, making it a yield-generating asset. When a user deposits 1 stETH into Pendle with a one-year maturity date, they receive:
- 1 PT-stETH: Redeemable for 1 stETH at maturity.
- 1 YT-stETH: Entitles the holder to all yield accrued over the year.
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This separation enables users to trade either the principal or the yield independently—effectively allowing fixed-income-like strategies in a decentralized environment.
Trading Strategies Enabled by Pendle
1. Fixed Interest Strategy – Buy PT Tokens
If 1 PT-stETH trades at 0.96 stETH, purchasing it locks in a return. At maturity, the holder redeems 1 full stETH, achieving an annualized yield of (1 / 0.96) - 1 = 4.16%. This mirrors a zero-coupon bond, offering predictable returns regardless of short-term price fluctuations.
2. Speculative Yield Strategy – Buy YT Tokens
Suppose the market prices YT-stETH at 0.04 stETH, implying an expected yield of 4%. If actual yield exceeds expectations—say, reaching 5%—the YT holder receives 0.05 stETH in rewards, yielding a 25% return on investment (0.05 / 0.04 - 1). Conversely, if actual yield is only 3%, the investor loses 25%. This creates three possible outcomes:
- Actual yield > Implied yield → Profit
- Actual yield = Implied yield → Break-even
- Actual yield < Implied yield → Loss
This dynamic allows sophisticated traders to express directional views on future interest rates.
Pendle V2: A Revolutionary AMM Design
Pendle V2 introduces a specialized Automated Market Maker (AMM) tailored for yield trading. Unlike standard AMMs like Uniswap V2 or V3, Pendle’s design optimizes capital efficiency and minimizes impermanent loss for liquidity providers (LPs).
Key Innovations in Pendle V2
1. Single-Sided Liquidity Pools (PT/SY)
Instead of maintaining separate pools for PT/YT or PT/Underlying, Pendle uses PT/SY pools, where SY is the standardized yield token (e.g., stETH). The system relies on the fundamental equation:
P(PT) + P(YT) = P(Underlying)
This mathematical relationship eliminates the need for direct YT trading pairs. Instead, YT trades are executed via flash swaps, leveraging arbitrage opportunities while maintaining pool balance.
2. Flash Swaps Enable Efficient YT Trading
When users buy or sell YT tokens, Pendle’s smart contracts perform atomic operations:
Buying YT:
- User deposits SY.
- Contract borrows additional SY from the pool.
- Mints PT + YT from SY.
- Sends YT to user.
- Sells excess PT back into the pool and repays borrowed SY.
Selling YT:
- User deposits YT.
- Contract borrows equivalent PT from pool.
- Redeems PT + YT for SY.
- Sends portion of SY to user.
- Sells remaining SY for PT and repays loan.
This elegant mechanism ensures deep liquidity without requiring direct YT/PT pools.
3. Reduced Impermanent Loss for LPs
Because PT prices converge toward the underlying asset value at maturity—and both PT and SY are highly correlated—the risk of impermanent loss is significantly lower than in traditional AMMs. This makes providing liquidity far more attractive and sustainable.
Multi-Chain Expansion & Growing Ecosystem
Pendle currently operates on Ethereum, Arbitrum, and BNB Chain, each serving different segments of the DeFi ecosystem.
Ethereum
Focuses on ETH-based yield assets like stETH and LSD-LP/WETH pairs. These assets are tightly correlated with ETH’s price, minimizing impermanent loss and attracting stable liquidity.
Arbitrum
Offers greater diversity with non-ETH pairs such as ARB-ETH and PENDLE-ETH. It also supports high-demand perpetual DEX LP tokens like GLP and gDAI, appealing to yield farmers seeking stablecoin-denominated returns.
BNB Chain
Recently launched, offering LSD derivatives tailored for BNB-native users. Future integrations with local DeFi protocols will expand product offerings and deepen ecosystem ties.
TVL growth since V2’s launch reflects strong adoption—particularly after expanding to Arbitrum and adding new asset pairs. Today, Arbitrum accounts for ~42% of total TVL, signaling strong traction beyond Ethereum.
From V1 Struggles to V2 Revival: A Founder’s Perspective
In an exclusive interview, Pendle co-founder TN Lee shared insights into the journey from near-collapse to resurgence.
“The TVL drop in 2022 stemmed from two factors: poor market conditions and expired markets in V1. But bear markets are ideal for reflection. User feedback and underperformance forced us to reevaluate our product’s fundamentals.”
While V1 validated demand for fixed-rate yield products, its AMM design suffered from high impermanent loss and inefficient capital use. Excessive token incentives were needed to attract liquidity—a unsustainable model.
V2 addressed these issues head-on:
- Introduced PT/SY pools with flash swap mechanics.
- Implemented an accounting system allowing LPs to earn ongoing rewards even when pooled.
- Enhanced capital efficiency and LP profitability.
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Future Outlook: Building the Yield Curve of Crypto
TN believes two asset classes hold immense potential:
1. LSD Assets
Post-Shanghai upgrade, ETH staking rates have become crypto’s de facto risk-free rate. With multiple maturities, this could evolve into a full-fledged yield curve, enabling complex fixed-income strategies akin to traditional treasury markets.
2. AMM LP Tokens
Liquidity provider tokens generate fees but suffer from poor pricing models and uncertain yield forecasts. Pendle aims to bring transparency and tradability to this space—unlocking new hedging and speculation opportunities.
Educational efforts are also central to Pendle’s strategy, including Lite/Pro mode toggles and comprehensive guides that simplify complex concepts.
Frequently Asked Questions (FAQ)
Q: What is Pendle Finance used for?
A: Pendle allows users to separate yield from principal in interest-bearing assets like stETH or LP tokens, enabling fixed-income strategies and speculative yield trading.
Q: How does Pendle reduce impermanent loss?
A: By using PT/SY pools where both assets are highly correlated and PT converges to underlying value at maturity, reducing volatility exposure for LPs.
Q: Can anyone create a new market on Pendle?
A: Yes—Pendle supports permissionless market creation for any compatible yield-bearing asset.
Q: What blockchains does Pendle support?
A: Ethereum, Arbitrum, and BNB Chain—with potential expansion to other EVM-compatible networks.
Q: How do users profit from YT tokens?
A: By buying YT when implied yield is low and holding until actual yield exceeds expectations—profiting from the difference.
Q: Is Pendle safe for liquidity providers?
A: V2’s improved AMM design significantly reduces risks compared to V1, offering better capital efficiency and reward sustainability.
Pendle Finance is redefining how users interact with yield in DeFi—transforming illiquid future cash flows into tradable financial instruments. As demand for structured products grows, Pendle stands poised to become a foundational layer in decentralized finance’s evolving landscape.
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