yield farming
Yield farming is when you use your crypto assets to generate returns. The tokens that are dormant in your account can be made available to the liquidity pool. You will generate more crypto with your crypto to provide liquidity. Yield farming is one of the most popular uses of decentralized finance, or DeFi. Two assets are usually required to farm the yield. Suppose you have both ETH and USDC that are not generating any income for you. You can start yield farming by providing liquidity to the ETH/USDC pool.
Leveraged yield farming
Leveraged Yield Farming (LYF) is what the name suggests. It is yield farming that uses leverage. LYF also allows you to borrow and farm these tokens to increase your returns. Suppose you put 100 USDT into a yield farming log. If you want to yield farm with just your 100 USDT, that means 1X leverage. If you borrow 100 USDT and wager that amount, it means you are using 2x leverage. Borrowing twice the amount you originally invested is 3x leverage and so on.
LYF is capital efficient, which means you can borrow more than you spend. This can strengthen your yield farming positions. As of this writing, 1X (that’s standard yield farming) yield farming on BUSD/USDT on Kalmar, a protocol based on Binance Smart Chain, yields only 4.7% APY. But if you choose the maximum possible 6x leverage, you get 44.05% APY!
Note that this capital efficiency works not only for farmers, but also for lenders. The first DeFi lending protocols were overcollateralised. That means you had to raise more than you could borrow. If your security was worth 100 USDT, you could only borrow, say, 90 USDT.
You could make that 90 USDT work for you and generate income, but it would be cool if you could borrow 100 or even more than 100 USDT, right? This means that utilization was low; only part of the borrowed money was borrowed from the peasants.
And this, in turn, means lower APYs for lenders since there is a supply and demand relationship between supply rates and interest rates on most lending platforms. High demand for loans made by lenders results in higher returns.
This is not the case with LYF. LYF platforms are more capital efficient as they allow undercollateralised loans. Since farmers can borrow more than they put up as collateral, they will put more funds to good use to generate additional income. This will drive up loan utilization, which in turn will result in higher returns for lenders. Leveraged yield farming is a win-win situation for both lenders and farmers.
risks
As with traditional financial markets, leverage is a double-edged sword in yield farming. First, there is an inconsistent risk of loss. Temporary loss is the most discussed risk among yield growers. When you provide liquidity to a pool, the dollar value of your token can go up or down.
This can result in the amount you withdraw being less than the amount you deposited. Therefore it is a loss and as it is not realized until you liquidate your position it is volatile as the token price can always go back to its original price. Like standard yield farming, leveraged yield farming exposes you to the risk of inconsistent losses.
An investor also faces a higher risk of liquidation with leveraged yield farming. Since you are borrowing funds to generate leveraged income, even a not very volatile move can lead to liquidations. The table below shows the relationship between the leverage level and a threshold for a potential movement in token prices that can lead to liquidation. If you are leveraged at the level of 3, a -31% move will result in the loss of your money. If you’ve been in crypto markets for a while, you might know that 30% volatility is not that rare.
One way to reduce liquidation risk is to farm the less volatile assets. Farming stablecoins is much less volatile than other tokens. Note, however, that the APY for leveraged yield farming with stablecoins is also lower than the more volatile tokens. You can also choose to add collateral if you are about to liquidate.
Other investing applications from LYF
Aside from increasing agricultural yields, leveraged yield farming can be used for various investment purposes. One of them is Holding company with leveraged returns. Let’s say you think SOL will do better; You can express your faith with the leveraged SOL 2X, but you might not like the idea of leverage.
This is where LYF comes to the rescue – you can farm with 2x leverage by borrowing a token that is different from the token you own. If you have 1,000 USD SOL, you can consider borrowing 1,000 USDC and start SOL USDC farming with 2x leverage. Or you can borrow another token, say AVAX, and do LYF SOL-AVAX at 2X. An investor has not leveraged their holding token but is managing it with leveraged returns. If he retires his LYF position, he returns the borrowed token.
Although holding with leveraged returns increases your returns, there is a risk of temporary loss. If the token you’re holding increases in value over a short period of time, you’ll suffer a temporary loss, which you’d do better just holding the token instead of farming. But if you do LYF for a long time, 2x returns can offset a temporary loss.
Note that if you perform LYF with a token-token pair (other than stablecoin), changing the price of the borrowed token would also cause a temporary loss. In our example above, if AVAX appreciates significantly in value, it will also result in fickle losses. But again, farming with the 2X lever can make up for that loss. Therefore, consider holding with leveraged returns as a long-term strategy.
Another trading idea that you can express through LYF is long levered. If you strongly believe that SOL (any token for that matter) will do well, you can leverage LYF > 2X with SOL-USDC. Say you have $1,000 and decide to borrow $2,000 USDC to leverage up to 3X. To achieve a 50:50 ratio, $500 of your $1,000 credits are swapped for $500 SOL. Now you have $1,500 SOL, which means you are leveraged 1.5x at SOL.
You can also do this with a non-stablecoin token. If you borrow $2,000 AVAX and want to do LYF with a SOL-AVAX pair, $500 AVAX will be exchanged for $500 SOL. Holding $1,500 SOL gives you 1.5x leverage on SOL. But there is a risk. When a portion of AVAX borrowing is swapped into SOL, it means you are shorting AVAX. This means you have a short position in AVAX. Whenever you perform LYF with >2X leverage, you have a short position in the borrowed token. You can consider doing LYF with a stablecoin to minimize this risk.
If you thought you could do it short levered you are right about LYF. The way to do this is to deposit a stablecoin, borrow the token you want to short, and farm the token-stablecoin pair with >2x leverage. If you think the SOL price will fall, you can deposit 1,000 USDC and borrow 2,000 SOL. $500 of your borrowing is converted to USDC to create a SOL USDC position. So you have $1,500 in the SOL short position.
Pseudo-delta-neutral yield farming
You can also benefit from leveraged yield farming even if you are not exposed to market direction. Pseudo-delta-neutral yield farming allows you to do it. Think of this strategy as a combination of leveraged long and leveraged short. First you create a leveraged long position on an asset and then you create a leveraged short position on the same asset. Because you earn returns regardless of market direction, it is delta neutral. But sometimes your position can move away from the neutral position as prices change; That’s why it’s called pseudo-delta-neutral farming.
Suppose you want to do pseudo-delta neutral farming with the SOL-USDC pair. First, you deposit 1,000 USD SOL and borrow 2,000 USDC, which means you have 3x leverage. You will farm SOL-USDC with $1,500 SOL and $1,500 USDC; so you are long at $1,500 SOL.
Then you deposit 3,000 USDC and borrow 6,000 SOL, of which 1,500 USD are exchanged for USDC. You farm with 4,500 SOL$ and 4,500 USDC USDC and you are 1,500 SOL$ short. Your long and short SOL positions cancel out and you earn a near-neutral return on your $4,000 ($1,000 + $3,000 you deposited).
LOADING
. . . Remarks & more!
Learn Crypto Trading, Yield Farms, Income strategies and more at CrytoAnswers
https://nov.link/cryptoanswers
Comments are closed.