Those of you involved in the cryptocurrency market, especially in the DeFi segment, must have heard the term “Leverage Farming” a few times. However, how is this leveraged farming mechanism different from traditional farming and is there any risk behind that you need to be concerned about? Follow along in the article below!!!
Uses of Leveraged Farm products
Probably many of you know "Leverage Farm" with its more risky and negative aspects, partly because of the word "leverage" in the name of this product. However, any product will have to have its use, in order to exist and attract the attention of users. So specifically, what problem does leverage farming deal with?
Reduce gas fees
First, with the Ethereum network, leveraged farming will help streamline transaction costs (gas gwei) for users. Imagine if you wanted to “short” a position with ETH, you would have to borrow ETH on platforms like Aave, Compound (because the liquidity above is stable), and then bring this money to traditional farming platforms to provide liquidity and conduct farming.
Thus, for the above steps alone, the amount of gas a user has to pay for both approval and swap is very large (even gas fees fluctuate based on the situation of the network at that time).
With leverage farming, users will streamline the above operation into a single step, saving gas but also fast.
Convenient experience
Second, if with new platforms (gas fees are not so important) like BSC or Solana, users still benefit from the lean product experience that these leverage farming products offer.
Going to find a source of liquidity will be taken care of by the leverage farming products themselves, your job is just to interact directly on their system.
Raise interest rate APY
Third, leverage farming helps speed up the reward, for “DeFi Degens” who want to make the most of their capital power. Instead of just farming with 100% APY, with leverage you can get 200 even 300% APY. However, there are risks involved, and in the next section I will explain the operating structure so that you can understand and fine-tune your own level of risk.
Mechanism of action
Imagine you have a thousand dollars idle (sounds like an Etoro ad, doesn't it?). Just kidding, imagine you have 1000 USD in ETH. If you go to a regular farm, the pools will have to divide 1000u of this value in a ratio of 50:50, ie 500u ETH : 500u USDT, then will start to calculate the % you occupy in the pool, thereby paying you the reward.
The traditional farming mechanism, as well as how to calculate the Impermanent Loss of farming will be explained by me in this article, if you are interested, you can learn it before we go into the leverage section. farming:
Some concepts to pay attention to
- Leverage Ratio: The total value of assets you want to put into the farm / Total capital assets that you contribute.
- Debt Ratio: Total value you borrow / Total value of assets you want to put on the farm.
- Allowed debt ratio (Max Debt Ratio): will be specified for each asset pool. If this limit is exceeded, your leveraged position will be liquidated.
For example, if you choose the leverage ratio x1.75. The asset you contribute is 1000u ETH as at the beginning. Total assets put into the farm = 1.75 * 1000 = 1750 USD.
Thus, you will borrow 750 USD -> Debt ratio = 750 / 1750 = 0.4286 (ie 42.86 %)
Some risks to consider
Why am I liquidated?
For example, the ratio of ETH and USDT prices is 1:3000 (ie 1 ETH for 3000 USD). When farming leverage x1.75 and the total order value is 1750u, the pool will have to split the ratio 5:5 between the 2 assets (ie ETH must be worth 875 USD and USDT also 875 USD).
Thus, if you put 1000u ETH in, your ETH side is being redundant, the pool will automatically sell this part of ETH (ie 125u = 1000-875). Your USDT side currently has 125, but still lacks 750 to qualify for 875. Therefore, the platform will borrow another 750u on its own.
Now, applying the formula mentioned above, your Debt Ratio will be 750 / 1750 = 42.86%.
Remember a rule, that as long as the collateral (the capital you actually contributed) decreases, automatically the debt ratio (Debt Ratio) will increase. And by the time this debt ratio hits the Max Debt Ratio, boom, your position is gone.
- So, in the example, since we deposit with ETH , so if ETH drops , you will lose collateral value .
- And if you initially choose to deposit 1000u entirely in the form of USDT , then when ETH drops, you are still safe, because most of your loan will go to the balance of ETH , thereby helping to ensure your Debt Ratio does not increase .
So, why am I “still” liquidated?
Don't forget that if you borrow money, you have to pay interest. Each leveraged farm position itself, at the bottom layer is still a normal lending transaction. Let's take the example in the figure below of the Solfarm platform.
We will have 2 payment options, that is in Tulip or USDC.
It is easy to see, paying fees in USDC will be higher than in Tulip. But don't let this number fool you.
If you provide collateral in Tulip , this cost will gradually add to your collateral , thereby pushing up the Debt Ratio leading to liquidation. Even if your Tulip value increases in USD, it is offset at a rate in Tulips (not USDT), so the increase in Tulip price will be meaningless in this case.
But what if you choose USDT? The system will also sell Tulip to USDT on its own and pay fees at the rate of 42%. And you will still be open, because the interest fee charged in USDT is much higher than TULIP.
So, is there a way to survive with these high fees? Let's go back to the general rule mentioned above, do everything to reduce the Debt Ratio!!! Thus, you can still receive a high reward from the farm, while not having to liquidate assets in a confusing way.
A recommended way to play
Based on the above principle, I have a recommendation for a way of playing that I personally find to be very effective (and this is definitely NOT investment advice).
- Step 1: The necessary condition is to choose a crypto-stablecoin asset pool (eg ETH-USDT, TULIP-USDC).
- Step 2: The sufficient condition is that the market will have to go downtrend. Only open a position when you predict the market will go down.
- Step 3: Choose to deposit assets in the form of stablecoins (USDT, USDC) and consider your leverage. Personally, I think x1.5 – x2 is reasonable.
- Step 4: Choose to pay fees in crypto. Why? Because the fee in % will be lower. And second, it's because this asset tends to fall in price, so when the system converts USDT to buy crypto to pay for fees, you will have to pay lower fees, reducing the risk of interest/fees on the asset. Mortgage.
- Step 5: Only close the position when the price of the crypto coin in the pool (ETH, TULIP) falls lower than when the position was opened. As it will cost you less USDT to buy this asset and pay it to the platform.
Ending
With that, we've gone through the basics as well as a few tips for using leverage farming products. If you are interested in in-depth information about the DeFi market, you can immediately join the Fomo Sapiens community with the admins of cryptobnb!!!
