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Unraveling Yield and Zero-Coupon Bonds
What is Pendle? Pendle Finance is bringing bond stripping to the Internet Financial System (’IFS’). The process involves splitting yield-bearing tokens into their principal and yield components.
The principle component entitles you to the principal of the underlying yield-bearing token, redeemable after maturity, but does not entitle you to any of the yield associated with the original token. For example, if you own 1 PT-stETH (where PT means ‘Principle Token’) with a 1-year maturity, you can redeem one stETH after a year but will forgo any staking rewards paid during the year. You can buy stETH principal token for 0.95 ETH and redeem it at the end of the year for 1.00 ETH for a ~5% return.
A yield token gives you rights to all the yield generated by the underlying yield-bearing token in real-time. The yield accrued can be manually claimed at any time on Pendle. For example, if you own 1 YT-stETH (where YT means ‘Yield Token’) and stETH has an average yield of 5% throughout the year, you would accrue 0.05 stETH by year's end. If you paid 0.04 stETH for this yield token, then you earned a 25% return on your investment. Both principal and yield tokens can be traded anytime, even before maturity, on Pendle’s purpose-built Automated Market Maker (AMM).
This maneuver mirrors the separation of principal and interest in bond markets, with principal tokens equivalent to zero-coupon bonds and yield tokens likening to coupon payments.
What are Coupon Payments and Zero-Coupon Bonds? To understand Pendle's mechanics, we must delve into bonds. Bond investors lend to issuers and earn returns through coupon payments —periodic interest payouts until bond maturity — and principal repayment at maturity. Zero-coupon bonds are bonds that don’t make any periodic payments to investors. They're sold at a discount and mature at face value, with the purchase-to-par value difference as the investor's gain. These bonds, either initially issued as such or converted by financial institutions stripping away their coupons, tend to see more price swings, given their full payout at maturity.
In bond stripping, both the principal and regular coupon payments of a traditional bond are separated and sold off individually, creating what's known as a strip bond or zero-coupon bond. Investment firms or dealers handle this division: an investor buying the separated principal gets an amount equal to the bond's face value at maturity, while an investor purchasing the coupons receives a steam of interest payments that ends at maturity.
Pendle — Key Concepts:
Maturity: Both principal tokens and yield tokens have a maturity date. The full underlying yield-bearing token can be redeemed for principal tokens after this date. Yield tokens accrue payments from the yield-bearing token up until the maturity date, after which yield tokens hold no value.
Underlying APY is the underlying asset's 7-day moving average yield rate. It provides a more accurate indication of the underlying yield over time, assisting traders in estimating Future Average Underlying APY better. This is a backward-looking APY.
Implied APY: The market's consensus of the future APY of an asset. Calculated based on the ratio of the price of a yield token to the corresponding principal token, it's an indication of where the market believes yield rates will move. You can see the Dec 2025 stETH has an Implied APY below its Underlying APY because the market expects ETH yields to go down over the next three years.
Long Yield APY: The estimated return (annualized) from buying the yield token at the current price, assuming the Underlying APY remains constant at its current value. This will overestimate your return when the Underlying APY is higher than the Implied APY.
Fixed APY: The guaranteed yield you receive by holding a principal token. This is the equivalent of the return on a zero-coupon bond.
We believe Pendle offers a compelling product and has found product-market fit within the Internet Financial System. The product is well designed and allows investors to speculate on specific interest rates within the industry. The market has taken note of Pendle, and the protocol has grown rapidly over the past six months.
Source: DeFi Llama
The Pendle protocol currently levies a 3% fee from all yield accrued by yield tokens on the platform, distributing this fee to token holders. This fee stream forms the bedrock of Pendle's business fundamentals.
We can build a quick mental model for Pendle revenue:
(1) revenue = total_value_locked * avg_yield * pendle_take_rate
As you can see below, Pendle currently manages about $81M of yield-bearing bonds, earning an average rate of 15%. Pendle token holders receive 3% of total yield generated by investors on the platform, amounting to approximately $360,000. If we solely consider this aspect of the business, which we will refer to as the core business for reasons discussed below, then Pendle is trading at approximately 240x core business earnings.
Pendle holders do not receive cash flows by default. Instead, Pendle holders need to lock up Pendle tokens for up to two years in exchange for vePendle and only vePendle token holders receive cash flows. The longer the lockup, the more vePendle the investor receives. There is only $15.2M of vePendle outstanding. If you only consider vePendle, the share class that receives cash flows, in valuation then Pendle’s core business in trading at a 42x price-to-earnings ratio.
However, Pendle has an entirely separate portion of its business centered around the AMM and ve Tokenomics. At present, Pendle is emitting about $10M of tokens per year to liquidity pools on its AMM. The vePendle token holders can vote on which liquidity pools will receive these tokens. In return, they earn 80% of swap fees from those pools. If you're unfamiliar with "ve Tokenomics," this might seem a bit complicated.
Pendle holders can lock tokens and receive vePendle, the share class that receives dividends and votes.
Token emissions are directed towards incentives for liquidity providers on the Pendle AMM. These token emissions equate to approximately $10M per year at current prices.
vePendle holders vote weekly on which pools receive these incentives.
In exchange, 80% of swap fees on the AMM are allocated to vePendle holders, with only 20% going to liquidity providers. The majority of the compensation for liquidity providers comes from Pendle tokens.
This part of the business is earning about $1.2M per year from swap fees, which translates to an approximately 8% yield for the $15M of Pendle tokens that are staked as vePendle. At this point, you could argue that Pendle tokenholders are really earning $1.6M ($1.2M from AMM swap fees and $0.4M from yield fees as described above). You could then debate whether this corresponds to a 56x price-to-earnings ratio (using circulating tokens) or a 13x price-to-earnings (using the $15M of vePendle as your market cap).
Pendle has increased its assets and revenue more than eightfold in the past six months. Earnings could potentially double or even quadruple by the end of the year. Is Pendle really trading at sub-20x earnings?
At Theia, we pride ourselves on being pragmatic value investors with a focus on downside protection. In our opinion, Pendle is trading at 240x earnings (this is the first earnings number we presented above). First, we decide to focus on circulating market cap of $87M instead of vePendle market cap of $15M because every Pendle token can be converted into a vePendle token (and many will if earnings yields become high enough).
Second, we remove the vePendle AMM business line from our calculations. This business line is operating at a loss by our standards. The vePendle AMM business line currently posts a loss of $8.8M, given that the issuance of $10M of Pendle tokens per year is essential to this business line's operation. If there were no Pendle emissions, then liquidity providers would not agree to the current 80-20 split where they are only earning 20% of trading fees. That's why we do not consider this to be part of the core business or factor it into our valuation. This leaves us with $0.4M of earnings relative to an $87M market cap.
Bottom line: Pendle Finance represents a novel approach to yield-bearing tokens. Pendle brings the TradFi practice of bond stripping, or the separation of principal and interest in bond markets, onto the Internet Financial System. The product is innovative, well-designed, and likely to see significant continued adoption.
We understand how vePendle holders may see this as undervalued or fairly valued — they are earning an 8% yield from a business that has grown eightfold in six months. However, our view is that Pendle is trading above 200x earnings in an industry where we typically like to buy below 20x earnings. While we acknowledge the bull case for Pendle — vePendle may yield higher and higher rates as Pendle grows, and liquidity providers may accept a small portion of trading fees even as Pendle incentives subside — we prefer to protect our downside through less optimistic assumptions.
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