Beware of Discount Rate Risk: AAVE, Pendle, and Ethena's PT Leverage Yield Strategy Mechanism and Risk Analysis

Recently, a striking strategy has emerged in the DeFi space, sparking widespread discussion. This strategy leverages Ethena's staking yield certificate sUSDe as a source of income in Pendle's fixed income certificate PT-sUSDe, and utilizes the AAVE lending protocol as a source of capital to conduct interest rate arbitrage for leveraged returns. While some DeFi opinion leaders are optimistic about this, the market seems to underestimate the risks involved. This article will share some insights on this strategy. Overall, the AAVE+Pendle+Ethena PT leveraged mining strategy is not without risks; the discount rate risk of PT assets still exists, and participants need to objectively assess the risks and control their leverage to avoid liquidation.

Analysis of the Mechanism of PT Leverage Income

The mechanism of this yield strategy involves three DeFi protocols: Ethena, Pendle, and AAVE. Ethena is a yield-generating stablecoin protocol that safely captures the short fee rates in the perpetual contract market through a Delta Neutral strategy. Pendle is a fixed-rate protocol that breaks down floating yield tokens into Principal Tokens ( PT ) and Yield Tokens ( YT ), which are similar to zero-coupon bonds. AAVE is a decentralized lending protocol that allows users to borrow other cryptocurrencies using cryptocurrencies as collateral.

The strategy integrates these three protocols: using Ethena's sUSDe as the source of returns in Pendle's PT-sUSDe, leveraging AAVE for funding, and engaging in interest rate arbitrage to obtain leveraged returns. The specific process is as follows: obtain sUSDe from Ethena, exchange it for PT-sUSDe in Pendle to lock in the interest rate, deposit PT-sUSDe as collateral in AAVE, and borrow USDe and other stablecoins, repeating the cycle to increase leverage. The returns are mainly determined by the base return rate of PT-sUSDe, the leverage multiple, and the AAVE interest rate spread.

The market status of this strategy and user participation

After AAVE recognized PT assets as collateral, the strategy quickly became popular. Currently, AAVE supports two types of PT assets: PTsUSDe July and PTeUSDe May, with a total supply of approximately 1 billion USD.

Taking PT sUSDe July as an example, the maximum LTV in E-Mode is 88.9%, theoretically allowing for about 9 times leverage. Without considering costs such as Gas, the theoretical maximum yield of the sUSDe strategy can reach 60.79%, not including Ethena points rewards.

In terms of the actual distribution of participants, taking the PT-sUSDe liquidity pool on AAVE as an example, a total of 450 million USD is provided by 78 investors, with a high proportion of whales and significant leverage. The leverage ratios of the top four addresses are 9 times, 6.6 times, 6.5 times, and 8.35 times, with principal amounts of approximately 10 million, 7.25 million, 5.75 million, and 3.29 million USD, respectively.

It is evident that investors generally allocate a high leverage for this strategy, but the market may be overly optimistic, and this risk perception bias could lead to a large-scale liquidation.

Discount rate risk cannot be ignored

Many analyses highlight that this strategy has low risk or even no risk, but this is not the case. There are primarily two risks associated with leveraged mining strategies: exchange rate risk and interest rate risk. Although USDe, as a mature stablecoin protocol, has a lower risk of price decoupling, this overlooks the specificity of PT assets.

PT assets have a concept of duration, and early redemption requires discount trading through Pendle's AMM secondary market, therefore the price of PT assets will fluctuate with trading, but generally tends towards 1. AAVE's design for the oracle of PT asset prices uses an off-chain pricing scheme, which can follow structural changes in PT interest rates while avoiding short-term market manipulation risks.

This means that when there is a structural adjustment in the interest rates of PT assets or a short-term market consensus is bullish, the AAVE Oracle will follow the changes, thereby introducing discount rate risks. If the increase in PT interest rates leads to a decline in PT asset prices, excessive leverage may face liquidation risks. Therefore, it is important to understand the pricing mechanism of the AAVE Oracle for PT assets in order to reasonably adjust leverage and balance risks and returns.

Key features include:

1. The Pendle AMM mechanism reduces price fluctuations caused by market trading as the expiration date approaches. The AAVE Oracle introduces the concept of heartbeat, which indicates the frequency of price updates; the closer it gets to the expiration date, the slower the updates, resulting in lower discount rate risk.

2. The AAVE Oracle uses a 1% interest rate change as a price update factor. If the market interest rate deviates from the Oracle rate by more than 1% and exceeds the heartbeat time, an update is triggered. This provides a time window to adjust leverage and avoid liquidation.

Strategy users should monitor interest rate changes and adjust leverage in a timely manner to control risk.