Two years ago, I wrote an article exploring the market potential of Pendle. At that time, the ETH Liquid Restaking (LST) sector was garnering significant attention, and LST projects were adopting "points" as a marketing mechanism. Users had a massive demand to trade these points, and Pendle, as a yield swap market, was perfectly positioned to facilitate this business.
While that article optimistically discussed Pendle's market cap, it also objectively flagged certain risks at the end. In the blink of an eye, two years have passed. The on-chain landscape has shifted significantly, yet certain inherent problems remain unchanged. The most critical issue is that the on-chain world lacks sufficient assets that generate external cash flow. This fact has remained constant for years and continues to constrain the further development of interest rate swap markets like Pendle. However, with shifting regulatory environments, a path to bringing ample external cash flow assets on-chain is becoming clearer, making this a key area to watch in the future.
In early 2024, Pendle’s TVL began to surge, driven by the LST sector. The underlying catalyst was the trend of using "points" as a new marketing meta. Initially, projects like EigenLayer (renamed EigenCloud) and Ether.fi attracted users to deposit funds via point incentives. Subsequently, they conducted phased token airdrops to points holders. Early depositors earned substantial returns, instantly validating "points incentives" as a marketing strategy accepted by the market. Later, other asset classes, such as Ethena’s USDe, adopted this strategy, making it standard procedure for the cold start of new projects.
Pendle’s original intent was to build a market for swapping yields on underlying assets. However, during this phase, a flood of pools emerged where the underlying assets possessed almost no organic yield.
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The chart reveals the shift in Pendle’s market categories. LST-type projects (ETH-related & BTC-related in the chart), where underlying assets have minimal external cash flow, are seeing their share shrink. Project teams must constantly launch new rounds of points/token incentives to generate demand, which is fundamentally unsustainable.
Conversely, USDe maintains a certain market share. The core reason is that the project generates external cash flow from funding rates, and this funding rate yield allows sUSDe to satisfy the "high volatility and unpredictability" characteristics mentioned in my previous articles. This creates real demand for yield swaps in the sUSDe market. Meanwhile, USDe market volume based solely on "points speculation" is gradually shrinking.
The emerging HYPE-related markets are similar to the LST-ETH markets. The underlying assets originate from validator businesses with low yields and almost no volatility. The vast majority of HYPE staker underlying yields are around 2.2%, generating little user demand for yield swaps. Current growth is driven primarily by expectations of project points/airdrops.
Currently, there are very few on-chain assets with real external cash flow. Categorically, these are limited to exchanges, lending, and funding rate arbitrage.
Taking Funding Rates as an example: Before October 11, the combined Open Interest for BTC across five major exchanges—Binance, OKX, Bybit, Hyperliquid, and Deribit—was approximately $35 billion. ETH Open Interest during the same period was about $21 billion, and SOL was around $6 billion. The three major tokens totaled $62 billion. Assuming the Funding Rate maintains an average of 0.01% per 8 hours, the annualized Funding Rate yield scale is approximately $6.8 billion. In other words, the scale Pendle can capture in the mainstream token Funding Rate sector is capped by the trading demand surrounding this $6.8 billion in yield variation. Demand naturally spikes when these rates are volatile.
On-chain Lending is an even smaller market. Aave, the largest, has outstanding loans of about $22.2 billion; Morpho is second with $3.4 billion; and Maple is third with only $1.5 billion. The top three total approximately $27.1 billion in loaned assets. Assuming borrowers are willing to pay interest slightly above the risk-free rate—let's assume 6%—mainstream lending protocols generate about $1.6 billion in lending yield. This is roughly one-quarter the size of the Funding Rate sector.
As for Exchanges, which possess the best external cash flow for on-chain assets, they are ill-suited for Pendle V2’s underlying asset stripping mechanism. This is due to either the "black box" nature of CEX profits or, in the case of Hyperliquid, the use of buyback-and-burn mechanisms rather than direct yield distribution.
As the regulatory environment in the U.S. becomes clearer, bringing RWA (Real World Assets) on-chain will no longer be limited to simple tokenized Treasury bills. While U.S. Treasuries provide stable external cash flow, their yield curves are too smooth and transparent, lacking room for speculation or trading.
If Treasuries are the bedrock of the "risk-free rate," then Pendle needs to find assets that possess a "risk premium." Underlying assets suitable for listing on Pendle must meet three strict criteria: long-term external cash flow, high yield volatility, and unpredictable yield changes.