Note: This article is not financial advice. Hubble Protocol does not endorse any of the tokens or platforms mentioned in this article.
Key Takeaways
- Leveraged yield farming is an advanced and high-risk DeFi strategy.
- Users can optimize LYF positions according to their market outlook.
- It's possible to take short, long, or delta-neutral positions with LYF.
This article will cover the basics of leveraged yield farming on Solana. This is the most advanced topic in Hubble's series on yield farming, so users might benefit from these introductory and intermediate articles if they're starting out:
- The Basics of Yield Farming in Crypto
- How to Start Solana Yield Farming as a Beginner
- What are the Best Yield Farming Strategies on Solana?
- Video: Yield Farming with Raydium
This article is not financial advice. Participating in decentralized finance (DeFi) through leveraged yield farming can increase the complexity of entering, tracking, and managing positions, so it’s highly recommended that novice users proceed with caution.
On the other hand, leveraged yield farming provides a lot of bells and whistles that can help active users earn yield in several market conditions. Even in down times, leveraged yield farming positions can be adapted to navigate market circumstances and earn yield.
Multiplying Token Rewards with Leveraged Yield Farming
Ever found an amazing yield farming opportunity and wished there was more capital on hand for that position? Disappointed that DeFi lending relies on over-collateralization and isn’t capital efficient? Tired of waiting for the market to “come back” to start yield farming again?
Users who replied yes to these questions might find some advantages to participating in leveraged yield farming. Protocols like Francium, Apricot Finance, and Tulip Protocol ease several pain points in yield farming by providing yield farmers access to their money markets to ramp up and customize their positions.
Each of these projects allows users to deposit tokens for lending, and they are then utilized to facilitate leveraged yield farming. Since the protocol–not the user–handles the yield farming position (borrowing, depositing liquidity, and auto-compounding rewards), loans can be under-collateralized to maximize capital efficiency as they mitigate the risk of unpaid debts.
Leverage maximizes exposure to a strategy with borrowed tokens, proportionately increases yield farming gains, and can minimize downside in case of liquidation. Borrowing assets to leverage yield farming allows users to multiply their initial position or follow different strategies based on where they think market trends are going.
Adjust Leveraged Yield Farming Strategies to Maximize Capital Efficiency
With leveraged yield farming, users can more easily find a way to successfully participate in yield farming in nearly every kind of market condition. By borrowing for leverage, users can take farming positions that are long, short, or delta neutral.
Yield farming is a DeFi primitive that emerged during the last bull market, and since the summer of 2020, every yield farmer has tried to find their own optimal strategy. Usually, they provide liquidity on an automated market maker (AMM), stake their LP token, and then they receive token rewards on top of the fees earned from being an LP (liquidity provider).
This is now essentially Yield Farming 1.0, or vanilla yield farming, and it’s not the most efficient way to deploy capital during certain market conditions.
Vanilla yield farming APYs can be enhanced with vaults that auto-compound rewards back into an LP position, and users can take it upon themselves to borrow the assets being farmed if they want to augment their position “by hand,” but as mentioned before, over-collateralized DeFi lending isn’t very capital efficient, and the process can be time-consuming.
The fees for executing each transaction can also eat into one's bottom line. However, thanks to Solana’s scalability and low cost per transaction, leveraged yield farming is a breeze. Getting started with leveraged yield farming on Solana is relatively simple, and protocols are working to make the experience more user-friendly with every update.
How to Start Leveraged Yield Farming for Beginners
Francium, Apricot, and Tulip each provide templates for setting up a leveraged yield farming position. This is a useful tool to help beginners get the hang of things, and from these templates, anyone can adjust which assets to borrow and in what proportion in order to better leverage their farming for the foreseeable future.
There are absolutely no guarantees that the strategy a user thinks will work will be the most capital efficient in the long run. However, leveraged yield farming protocols at least allow DeFi users to more easily follow through on their convictions about the market without having to resort to multiple protocols.
In the next sections, this article will explain what it’s like to take various positions on three of the major protocols that offer leveraged yield farming on Solana. There will be some variety between projects, as each protocol takes a slightly different approach to the templates provided.
Longing Leveraged Yield Farming Positions
In these positions, users borrow stablecoins and swap them for the token they want to long. Here’s an example from the Tulip garden on a 2x leveraged long SOL position.
Notice how only USDC is borrowed. It’s swapped into SOL by the protocol to create a long position.
Looking at the graph that estimates future price action, the "farm profit" follows a similar trend line to holding. Impermanent loss (IL) sets in at the higher and lower ends of price action.
Now, here's a look at what a 3x leveraged long position can look like.
Here, there is more exposure to SOL, but the liquidation threshold has moved much further up the chart toward the current price. Notice how the farm profit from SOL’s price appreciation outpaces profits from holding.
Shorting Leveraged Yield Farming Positions
When users short a position, they'll borrow the token they believe will depreciate in value during the course of their farming. Here’s an example of what it looks like to 3x short SOL on Francium.
The graph shows that farm profits increase with the depreciation of SOL’s value. This is because the SOL for this position has been borrowed, and when it’s time to return this SOL, there should be more of it in the position. As SOL's price declines, the LP position on an AMM will rebalance due to arbitrage, and by doing so, it will essentially DCA (dollar cost average) into a heavier SOL position.
This position borrowed 127.81 SOL. If this leverage short position is unwound after SOL drops in value, then there should be more SOL on hand to return than was originally borrowed.
If the value of SOL increases, on the other hand, this position could face liquidation.
Neutral and Pseudo-Delta Neutral Leveraged Yield Farming Positions
Apricot allows users to choose a neutral template that borrows both assets. This is not the same thing as “longing both sides,” which requires first borrowing stablecoins and then swapping for two volatile assets one believes will appreciate in value.
The same values shown in the examples before have been lent on Apricot in order to participate in leveraged yield farming on its platform: 1,841.25 USDC and 11.76 SOL. Notice the size of the position that can be taken with a neutral template strategy.
This position only leaves about a 10% buffer before a liquidation is triggered, but there is quite a bit more capital being used to yield farm than what was originally on hand!
In a pseudo-delta neutral position, the ratio of borrowed assets is tweaked a bit to accommodate a crab market with some leeway for price depreciation. Notice how the graph reacts when USDC/SOL is borrowed at a 25%/75% ratio.
Yield Farming and Users Have Evolved With Leveraged Positions
Historically, yield farming has been prone to attracting toxic liquidity, the practice of farming a new project for rewards and withdrawing liquidity within the first 48 hours, dumping tokens along the way. This has proven to be an unsustainable model for the DeFi community, for obvious reasons.
Nearly all of the leveraged yield farming opportunities provided in these examples can be taken advantage of for longer than 48 hours without taking advantage of the system. Tokens have to be lent out before they can be borrowed for leverage (someone has to hold them), and this seems to cut out the opportunity for shitcoin farming.
Some vocal members of the DeFi community have noted that yield farming is dead, but maybe it’s just taken a new, more mature, form. It’s a far cry from ponzinomics.
Users who take advantage of leveraged yield farming to participate in sustainable practices for earning yield are exposing themselves to possibly greater risks and possibly greater rewards, but they’re also increasing the capital efficiency of providing liquidity through traditional AMMs (concentrated liquidity is a different ball game).
While leveraged yield farming might look incredibly degen, it’s really more closely aligned with realistic goal setting and sustainable DeFi than yield farms built for the sake of yield farming.
Users who spend the time to tweak the parameters of their leveraged yield farming positions have the possibility of discovering strategies that could yield net positives even outside the frenzy of a bull market and with great capital efficiency.
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