Understanding Pendle and Boros: Turning funding rate into DeFi derivation

This article analyzes how Pendle, in collaboration with Boros, transforms the fluctuating funding rate into stable and predictable returns, thereby fundamentally changing the DeFi derivatives strategy for institutional investors. This article is based on a research tweet by Tiger Research titled "Pendle and Boros: Turning Funding Fees into DeFi Derivatives," organized, compiled, and authored by AididiaoJP and Foresight News. (Background: Pendle bets on Terminal Finance: a new game for leveraging institutional funds) (Context: Pendle is complex, but not understanding it is your loss) Summary Core Problem Solved: Institutions need stable returns but the funding rates fluctuate wildly, Boros converts volatility into fixed returns Market Opportunity: First-mover advantage in the DeFi derivatives space, becoming an indispensable infrastructure for neutral strategies like Ethena Delta Expanding Suite Vision: Expanding from crypto funding rates to traditional finance (bonds, stocks), leading the on-chain derivatives market Undeveloped Areas Behind DeFi Success Although the crypto market has given rise to many narratives, DeFi and derivatives trading have demonstrated the strongest product-market fit. The early growth of DeFi came from lending protocols such as Aave and Compound, decentralized exchanges like Uniswap, and yield farming mechanisms. These rebuilt core financial primitives in a permissionless environment, opening access previously limited to institutions. As these markets matured, DeFi began to expand into the derivatives space, following a trajectory similar to traditional finance. In traditional markets, derivatives far outsize spot trading in scale and liquidity. A similar transformation is occurring in the crypto space, with permissionless derivatives becoming the next growth driver. Pendle: Financial Engineering in DeFi Source: Pendle Pendle was launched in 2021 and positions itself as the leading project introducing structured derivatives into DeFi. Its entry point is the separation of principal and yield of interest-bearing tokens. The timing is very effective: yield staking is becoming mainstream, and by 2023, narratives around staking and future airdrops are increasingly prominent, attracting more attention to Pendle. Today, many new projects integrate Pendle as a foundational layer for yield-related strategies. Its core mechanism seems simple but effectively creates two distinct asset classes: a discounted claim on future value (PT) and a product purely exposed to interest rate fluctuations (YT). The impact is significant. With Pendle, yield-bearing assets like stETH or rETH are no longer limited to serving as staking substitutes; they can now be building blocks for more complex strategies. Investors seeking to leverage rising yields can purchase YT and gain leveraged positions that may exceed six times depending on market conditions. Conversely, investors pursuing fixed returns can buy PT, which typically locks in a double-digit discount relative to future value. More importantly, Pendle's design enhances capital efficiency across DeFi. Strategies that once required complex hedging or derivatives expertise are now simplified through its yield-splitting mechanism. Investors can now access, trade, and customize yield positions on-chain. By doing so, Pendle not only introduces a new yield concept but also lays the groundwork for financial engineering in DeFi, providing institutional-grade tools to users in a permissionless manner. Boros: Empowering Delta Neutral Yields As the crypto market expands, institutions are deploying larger capital bases and adopting more complex trading strategies to generate returns. Their priority is stable returns, typically achieved through delta-neutral positions to minimize price risk. Ethena showcases this by holding spot ETH while shorting an equivalent position in the futures market. The gains on one side offset losses on the other, keeping the portfolio value stable regardless of price direction (see diagram). In a bull market, longs pay the funding rate to shorts, allowing Ethena to earn income. In a bear market, the opposite is true, and Ethena must pay the funding fee. The challenge lies in the nature of funding flows being inherently unstable; sometimes generating income and other times requiring payment. This volatility undermines protocols like Ethena that rely on delta-neutral strategies to support their stablecoin USDe. Source: Pendle Boros addresses this gap by converting unstable funding fee flows into fixed, predictable returns. In doing so, it provides institutions with the stability needed to expand capital deployment in the crypto market. Boros Mechanism: Stable Funding Rate Boros introduces Yield Units (YU), a derivative that separates the volatility of funding rates from the underlying asset prices. YU allows for two things: directional bets on funding rates and the conversion of unstable funding flows into predictable income streams. The following section explains its mechanism. Yield Units (YU): Structure and Purpose Assume an investor wants to achieve an 8% fixed annualized return within three months, regardless of whether the Bitcoin funding rate is positive or negative. Conversely, another investor may prefer direct exposure to the volatility of funding rates, willing to pay fixed returns in exchange. YU connects these two parties by isolating and trading only the volatility of funding rates (independent of movements in the underlying asset prices). Source: Boros, Tiger Research For example, the product "1 YU-ETHUSDT-Binance" represents the funding rate yield for a perpetual contract nominal position of one ETH on the Binance exchange until expiration. Purchasing this product allows the investor to profit or lose based on changes in the funding rate associated with that position without having to hold ETH itself. In this way, YU transforms the funding rate of a specific exchange-asset pair into an independent, tradable tool. Implied Annual Percentage Rate (Implied APR): Market Expectations as Price Signals Source: Boros, Tiger Research A core concept of YU trading is the implied annual percentage rate. This represents the market’s expectation for average funding rate yields until expiration, reflected in the current price of YU. Just as an $80,000 Bitcoin price reflects the market's valuation of that asset, a YU-BTCUSDT 8% implied annual percentage rate indicates that participants expect the Bitcoin funding rate to average 8% annually over the relevant period. In short, the function of the implied annual percentage rate is similar to the market price in futures markets: it reflects the market's consensus viewpoint at the moment. Long/Short Top Positions: Trading Implied Yields vs. Actual Yields YU positions are similar to futures trading, but the motivations of longs and shorts differ. Bitcoin futures long: Mark price $50,000 → Target price $60,000 = $10,000 profit YU long: Implied annual percentage rate 8%...