Understanding Indicative APY vs Realised ROI (hyETH)

hyETH’s performance is not guaranteed to be “up only”, and the interim performance of hyETH may not always match the indicated APY for all users at all times.

In this article we will explore the concepts of indicative APY (Annual Percentage Yield), and what factors and scenarios will affect the actual Return On Investment (ROI) experienced by holders of hyETH (as well as other risks to consider).

Note that the indicative yield of hyETH will be displayed alongside the product on Index Coop’s website and is calculated by taking a weighted average of the underlying components in real-time.

A quick recap on hyETH:

hyETH offers users with higher risk tolerances exposure to high ETH-denominated yields from across DeFi without having to track, manage or maintain multiple and sometimes complex positions. For more information visit indexcoop.com/hyETH

hyETH is made up of several high-yielding strategies:

For an overview of how these yields are derived please see Introducing: High Yield ETH ($hyETH) by Index Coop

The primary purpose of this article is to explore the nuances surrounding Pendle PT positions. These are more complicated than the Instadapp and Across strategies and the higher yields come with more risk.

Recently Pendle has experienced a rapid growth in users and TVL. This has largely been driven by users speculating on the value of potential airdrops and using leverage to gain increased exposure. This is down to the unique way in which Pendle works. 

Pendle is a DeFi protocol that facilitates yield speculation through the separation of yield-bearing assets into two types of tokens: Principal Tokens (PTs) and Yield Tokens (YTs).

Principal Tokens (PTs): These tokens offer a fixed yield by locking yield-bearing assets for specific durations at a discount. At maturity, PTs can be redeemed 1:1 for the underlying asset. PTs have some similarities to zero coupon bonds in that they provide a fixed return and are issued at a discount to their maturity value.

Yield Tokens (YTs): YTs provide a variable yield above the fixed rate offered by PTs. If the average underlying yield during the duration exceeds the fixed rate on PTs, YT holders benefit. However, if the average yield falls below the fixed rate, YT holders receive no yield. This structure allows users to take leveraged bets on yield fluctuations.

Users can speculate on future yields by purchasing YTs, aiming to profit from favourable yield outcomes. Pendle's protocol enables users to engage in yield speculation while also providing liquidity for others to access yield opportunities.

In summary, Pendle allows users to participate in yield speculation by separating yield-bearing assets into fixed-yield PTs and variable-yield YTs, providing opportunities for both risk and reward in DeFi yield farming.

Users can use leverage and speculate on airdrops by holding YTs as any additional value accrues to them over the PTs. This surge in demand for YTs increases their price which in turn decreases the price of PTs. As the price of PTs fall, the yield increases as they are essentially trading at a steeper discount to their redemption value at maturity.

It is therefore evident that the price of PTs can fluctuate, influenced by market expectations not only of APYs but also speculation regarding the value of airdrops. A simple guideline to remember is that the price of PTs has an inverse, proportional relationship with expectations of yields and additional value accruing to YTs. 

When implied rates increase, the value of PTs decrease, and vice versa. Since hyETH consists primarily of LRT PTs, these fluctuations can impact the value of hyETH daily. For instance, if a hyETH holder enters the market on day 1 and implied yields on Pendle increase significantly, the PTs' value will drop, resulting in a short-term loss if the holder redeems hyETH for ETH before the PT recovers in value; however, if the holder waits until maturity, they will not experience this loss.

This effect is more pronounced over shorter periods, with users expecting a return on investment (ROI) of 1% within approximately 12 days if the indicative yield of hyETH is ~30%. However, if PTs' value falls by 2%, users could experience a negative ROI in this time frame if they redeem for ETH. Annualised, this effect becomes more significant. Hence, it's crucial for users to distinguish between indicative APY and their actual ROI, which can vary based on entry and exit timings and changes in PTs' prices. To mitigate temporary negative ROIs, users can extend their holding periods to allow PTs to reach their par value at maturity, thereby realising the indicative APY at the time of entry.

Another risk to consider is the conversion rate between PTs and ETH. LRTs themselves have a conversion rate to ETH. Since PTs are effectively wrappers around LRTs, any movement in the LRT/ETH price will also affect the PT/ETH exchange rate. At the time of writing Swell Network does not yet enable withdrawals for their re-staking token rswETH (note: this differs from ETH withdrawals for the LST swETH).

Without withdrawals, any users wishing to exit their rswETH can only do so using secondary market liquidity. If significant amounts of rswETH were to be sold there is no arbitrage mechanism to bring the LRT back towards its underlying value. As users sell rswETH the value will fall, sometimes colloquially known in DeFi as a “de-peg”. Renzo Restaked ETH (ezETH) is such an example. On April 24th 2024 the secondary market price fell from 1.009 to as low as 0.864 ETH before recovering to 0.975, a drop of 3%.

Summary

To recap, hyETH holders should carefully consider when to flash redeem their position to ETH. If an LRT or PT has fallen in value between a user entering and exiting a position, their ROI could in some cases be negative (even though at the time of entry the indicative APY was strongly positive).

To help mitigate such instances, users should check that the redemption value matches their expected return. If an underlying component has experienced a fall in its ETH value, it is likely beneficial to continue holding until the PT matures or the LRT can be fully redeemed in order to realise its true value. Note that this is just a generalised guide. Users must research and decide for themselves if the value of an underlying component is likely to return to its expected longer term value.

Index Coop will provide analytics and content to help users clearly navigate these complexities. 

In the event users want to redeem their hyETH position, but do not want to realise a loss on a particular component, Index Coop always enable users to permissionlessly redeem hyETH for all the individual underlying assets. Like all Index Coop products, hyETH will be 100% collateralised at all times and fully redeemable. After an in-kind redemption, a user can sell / redeem the components that have not experienced a fall in value and choose to hold on to the PT or LRT and wait for it to regain its value.

Conversely, hyETH may provide a useful tool to gain exposure to opportunities when assets are trading below a future fair value.

hyETH is available (to non-restricted persons) via the Index Coop App. For any additional questions, try our hyETH FAQ page.

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