Pendle and Boros: Transforming Funding Rates into DeFi Derivatives

Author: Ryan Yoon, Source: Tiger Research, Translated by: Shaw Golden Finance

This article analyzes how Pendle, through Boros, transforms volatile financing fees into stable, predictable returns for institutional investors, thereby revolutionizing decentralized finance (DeFi) derivatives.

TL;DR

Core Problem Solved: Institutions want stable returns, but funding fees are unstable - Boros converts volatility into fixed income

Market Opportunity: First-mover advantage in the DeFi derivatives field, becoming an important infrastructure for delta-neutral hedging strategies such as Ethena

Expanding Vision: Expanding from crypto asset funding rates to traditional finance (bonds, stocks), leading the on-chain derivatives market

1. The untapped areas behind DeFi's success

While the crypto market has generated many narratives, decentralized finance (DeFi) and derivatives trading have demonstrated the strongest product-market fit. DeFi’s initial growth stemmed from lending protocols like Aave and Compound, decentralized exchanges like Uniswap, and yield farming mechanisms. These mechanisms rebuilt core financial primitives in a permissionless environment, opening up services previously limited to institutional users. As these markets matured, DeFi began to expand into derivatives, following a similar trajectory to traditional finance. In traditional markets, the scale and liquidity of derivatives far exceed spot trading. A similar shift is happening in cryptocurrency, where permissionless derivatives are becoming the next growth driver. 2. Pendle’s role in financial engineering in DeFi Pendle discovered this opportunity early on and launched in 2021, positioning itself as a leading project introducing structured derivatives into DeFi. Its entry point is to decouple principal and yield from yield tokens. Its timing is perfect: yield staking is becoming increasingly mainstream, and the narrative of staking and future airdrops is gaining momentum by 2023, garnering increased attention. Many new projects are now integrating Pendle as a base layer for yield-related strategies. While its core mechanism may seem simple, it actually creates two distinct asset classes: a discounted claim on future value (PT) and pure exposure to interest rate volatility (YT). The impact is significant. With Pendle, yield-generating assets like stETH or rETH are no longer limited to serving as collateral substitutes; they can now become the building blocks for building more complex strategies. Investors seeking rising yield can purchase YT, gaining up to six times leveraged exposure (depending on market conditions). Conversely, investors seeking fixed income can purchase PT, often locking in returns at a double-digit discount to future value. More importantly, Pendle's design improves capital efficiency in DeFi. Strategies that previously required complex hedging or derivatives expertise are now simplified through its yield-splitting mechanism. Investors can now access, trade, and customize yield exposure on-chain. In doing so, Pendle not only introduces a new concept of yield but also lays the foundation for financial engineering in DeFi, providing users with permissionless, institutional-grade tools. 3. Boros: Enhancing Delta-Neutral Returns As the cryptocurrency market expands, institutional investors are investing larger amounts and employing more sophisticated trading strategies to generate returns. Their primary focus is achieving stable returns, which they typically achieve by minimizing price risk through delta-neutral positions. Ethena demonstrates this by holding spot ETH and simultaneously shorting an equal amount of futures. Gains on one offset losses on the other, maintaining a stable portfolio value regardless of price movements (see figure). In a bull market, longs pay shorts funding fees, and Ethena earns revenue. In a bear market, the opposite happens, and Ethena must pay fees. The challenge is that funding flows are inherently volatile—sometimes generating income, sometimes requiring expenses. This volatility undermines protocols like Ethena, which rely on delta-neutral strategies to support its stablecoin, USDe. Boros fills this gap by transforming volatile funding streams into fixed and predictable returns. In this way, it provides the stability institutions need to expand their capital allocation in the cryptocurrency market. 4. Boros Mechanism: Stable Funding Rates Boros has launched Yield Units (YUs), a derivative instrument that isolates funding rate fluctuations from the price of the underlying asset. YUs simultaneously fulfill two functions: providing directional bets on funding rates and transforming volatile funding flows into predictable income streams. The following section explains their mechanics. 4.1. Yield Unit (YU): Structure and Usage Imagine an investor seeking a fixed annualized return of 8% over three months, regardless of whether Bitcoin funding rates fluctuate positively or negatively. Conversely, another investor might prefer to directly incur funding rate fluctuations and be willing to pay a fixed return. YUs connect these two parties by isolating and trading the volatility of funding rates, independent of price fluctuations in the underlying asset. For example, the product "1 YU-ETHUSDT-Binance" represents the funding income from holding a 1 ETH notional position in the Binance perpetual contract until expiration. After purchasing this product, investors can profit or lose based on the changes in funding associated with this position without holding ETH itself. In this way, YU transforms the funding costs of a specific exchange asset pair into a standalone, tradable instrument. 4.2. Implied Annual Percentage Rate (APR): Market Expectations as Price Signals A core concept in YU trading is the implied annual percentage rate (APR). It represents the market's expectation of the average funding rate before maturity and is reflected in the current price of YU. Just as the $80,000 Bitcoin price reflects the market's valuation of the asset, YU-BTCUSDT's 8% APR indicates that participants expect Bitcoin funding fees to average 8% per year over the relevant period. Simply put, the implied annual rate acts much like the market price in the futures market: it reflects the current market consensus. 4.3. Long-Short Positions: Trading Implied and Actual Yields Similar to futures trading, YU positions have different motivations for long and short positions.

• Bitcoin futures long: Mark price $50,000 → Target price $60,000 = $10,000 profit;

• YU long: Implied APR 8% → Actual APR 10% = 2% profit (the long position pays the implied APR and receives the actual APR).

A long YU position reflects the belief that "the actual funding rate will be higher than the market's current expectation of 8%, such as 10%." In this case, the long position pays the implied APR (8%) and receives the actual APR (10%). This is equivalent to saying, "Bitcoin futures are currently priced at $50,000, but I expect it to rise to $60,000," and then going long.

• Bitcoin futures short: Mark price $50,000 → Target price $40,000 = $10,000 profit

• YU short: Implied APR 20% → Actual APR 15% = 5% profit (short seller receives the implied APR and pays the actual APR)

A YU short position reflects the belief that “the actual funding rate will be lower than the market’s current expectation of 20%, say 15%.” The short seller receives funding at the implied APR (20%) and pays funding at the actual APR (10%). This is akin to saying, “Bitcoin futures are currently trading at $50,000, but I expect them to fall to $40,000,” and then shorting the contract. Simply put, Bitcoin futures represent a bet on the current price versus the future price, while YU represents a bet on the current market expectation (implied APR) versus the realized funding outcome (actual APR). Since the funding rate resets every 8 hours, the return depends on whether the realized rate is above or below the market expectation at that time. 5. Applying Boros in a Delta-Neutral Strategy What practical uses does YU have for institutions? To illustrate, consider how Boros addresses the funding rate volatility challenges faced by Ethena. Suppose Ethena operates a delta-neutral strategy involving 100 ETH. It holds 100 ETH in the spot market and simultaneously shorts 100 ETH in the futures market. The core issue with this setup is the volatility of funding rates: in a bull market, the short position receives funding, but in a bear market, it must continue to pay funding fees. To stabilize this risk exposure, Ethena established an additional short position in "100 YU-ETHUSDT-Binance" with an implied annualized yield of 10%. This means it receives a fixed 10% return on the notional value of 100 ETH while paying the actual funding fees incurred. As shown in the table, the variable funding income from futures contracts is offset by the variable funding payments in Boros. In fact, even if positive funding is received, an equivalent funding payment is made through the Boros contract, so the net effect is fixed at zero. This leaves the fixed 10% return provided by Boros. Combined with the 4% staking income, Ethena achieves a predictable total return of 14%. However, this approach comes with trade-offs. Institutions must allocate additional margin to maintain these positions, and volatile price fluctuations can introduce liquidation risk. Therefore, investors like Ethena need to apply YU within a sound risk management framework. 6. Pendle's Next Target: Traditional Finance While the Ethena example demonstrates how YU can be applied to a single delta-neutral strategy, Boros' potential goes far beyond this. Boros's scope extends far beyond funding rates. Currently, it runs on Arbitrum and supports BTC and ETH perpetual markets from Binance, as well as ETH markets from Hyperliquid. However, institutions don't limit their delta-neutral strategies to a single exchange. To manage risk and capture arbitrage opportunities, they diversify across assets and venues. Therefore, expansion is crucial. Boros plans to add support for assets like Solana and BNB, and integrate with exchanges including Bybit. This will broaden investors' access to the funding rate market. However, Pendle's ambitions go further. These strategies are unlikely to be limited to institutions. As Boros matures and diversifies, we expect sophisticated individual investors will also be able to participate. Even for those who don't directly employ such strategies, the funding rate is bound to become a widely watched indicator of market sentiment and positioning, shaping the trading environment for both institutional and retail participants. The broader vision is to bridge traditional finance. Pendle has outlined plans to incorporate benchmarks and instruments such as LIBOR, mortgage rates, bonds, and stocks. Unlike the familiar path of "traditional finance absorbing crypto assets," Pendle is taking the opposite approach, applying cryptographic technology architecture to reconstruct traditional instruments on-chain. Overall, Pendle's expansion is cause for optimism. Growing institutional participation and their demand for more advanced strategies are likely to further enhance its role in the market. More importantly, Pendle is not just following the transformation of traditional finance; it shows the potential to become a leader in shaping the future of global markets – a vision that deserves recognition.