Mechanism and Risk Analysis of PT Leverage Strategy

Recently, a noteworthy strategy has emerged in the DeFi space: utilizing Ethena's sUSDe, Pendle's PT-sUSDe, and AAVE's lending features for interest rate arbitrage to obtain leveraged returns. Although this strategy has garnered considerable attention and discussion, some of the risks involved seem to have been overlooked by the market. This article will analyze the mechanics of this strategy, the current market situation, and the potential risks.

Strategy Mechanism Analysis

The strategy involves three DeFi protocols:

1. Ethena: A yield-generating stablecoin protocol that captures the short-selling fees of the perpetual contract market with low risk through a Delta Neutral strategy.
2. Pendle: Fixed-rate agreement that decomposes floating yield rate tokens into Principal Token (PT) and Yield Certificate (YT).
3. AAVE: A decentralized lending protocol that allows users to collateralize assets to borrow other cryptocurrencies.

Strategy Process:

1. Get sUSDe on Ethena
2. Exchange sUSDe for PT-sUSDe fixed rate through Pendle
3. Deposit PT-sUSDe into AAVE as collateral
4. Lend USDe or other stablecoins
5. Repeat the above steps to increase leverage.

The yield is mainly determined by three factors: the base yield rate of PT-sUSDe, the leverage multiplier, and the interest rate spread of AAVE.

Market Status and User Participation

After AAVE supported 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 US dollars.

Taking PT sUSDe July as an example, the maximum leverage can reach 9 times. Theoretically, at maximum leverage, not considering other costs, the strategy return rate can reach 60.79%( excluding Ethena point rewards).

Actual participation situation:

• The total amount of the PT-sUSDe liquidity pool on AAVE is 450 million USD, provided by 78 investors.
• The leverage ratio of the top four investors ranges from 6.5 to 9 times, with principal amounts between 3.3 million and 10 million USD.

Investors generally use higher leverage, and market sentiment may be overly optimistic.

Discount Rate Risk Analysis

There are two major risks associated with this strategy:

1. Exchange rate risk: A decrease in the exchange rate of the collateral and the loan target leads to liquidation.
2. Interest Rate Risk: An increase in borrowing rates leads to negative strategy returns.

Most analyses believe that the exchange rate risk is relatively low, but they overlook the specificity of PT assets. The price of PT assets will change with transactions, gradually approaching 1.

AAVE adopts an off-chain pricing scheme for PT assets, and the Oracle price will follow changes in market interest rates. This means:

1. When the PT interest rate structure is adjusted, the Oracle price will change accordingly.
2. When the market has a consistent expectation of interest rate changes, it will also lead to price fluctuations.

Therefore, PT assets are subject to discount rate risk. If PT interest rates rise and lead to a price decline, excessive leverage may face liquidation risk.

Key features of the AAVE Oracle pricing mechanism:

1. As the expiration date approaches, the frequency of price updates decreases, and the discount rate risk decreases.
2. If the deviation between the market interest rate and the Oracle interest rate exceeds 1% and persists for a certain period, it will trigger a price update.

Strategy users should closely monitor interest rate changes and adjust leverage in a timely manner to maintain a balance between risk and return.