What Is Leveraged Yield Farming and Is It Worth the Risks? by@pembrock
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What Is Leveraged Yield Farming and Is It Worth the Risks?

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Leveraged yield farming is the practice of borrowing funds in order to boost returns. The top products on the market offer users the ability to borrow anywhere between one and three times their holdings. One can employ different strategies, such as shorting one token while longing another as a hedge against volatility (this is only possible when leveraging by 2x or more). The main risks involved in farming and leveraging are impermanent loss, liquidation, and hacks.

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@pembrock

Sofia Pidturkina

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Regardless of the current dip in the crypto market, the DeFi sector continues to expand, utilizing Ethereum and other prominent layer 1 and layer 2 blockchains. This expansion can be seen with product development that incorporates decentralized monetization and other financial operations into applications that are focused on gaming, social media, music, metaverses, the environment, and much more.

Amidst the huge range of new DeFi initiatives, in this article, we are going to focus on leveraged yield farming. Why do we think it's a topic worth exploring?

  • Yield farming helped to fuel the DeFi boom of 2020.
  • Leveraging in trading brings risk but also high reward.
  • These platforms are trending across the top layer 1 blockchains.
  • Leveraging opens up strategies that can profit from bear market conditions.

Leveraged yield farming brings new opportunities to users and is helping to increase investment and liquidity in the major blockchain ecosystems, making it a really worthwhile topic to dive into. By the end of this concise post, you’ll have an understanding of:

  • What yield farming is.
  • How leveraging changes the equation (with examples!)
  • How different strategies are employed for success.
  • What the risks are and how to counter them.
  • The key players in this field.
  • How to farm, with a step-by-step demo using our product, PembRock Finance.

What Is Yield Farming?

Yield farming simply refers to the process and rewards involved in lending out tokens to a protocol, contributing to the liquidity required for operations such as swaps and borrowing in DEXes and lending platforms. But wait a minute; lending and liquidity provision also involve supplying funds to these platforms, so what are the differences?

  • Lending often involves locking up one coin on a platform. It is typically low-risk and is popular with people who wish to get predictable returns on their stablecoins.

Example A user lends their Tether for 6% APY.

  • Liquidity Provision involves lending two coins (or sometimes more) at an equal ratio to be locked in a liquidity pool. These pools are used by Automated Market Makers (AMMs) to facilitate instant and automated token swaps through predefined rules written into smart contracts, rather than through the traditional order book model employed by centralized exchanges. As proof of having added tokens to the pool, the user receives a liquidity provider (LP) token representing their share. The LP token is the key to redeeming funds, and this is where farming comes in.

  • Farming takes liquidity provision a step further, as LP token holders are incentivized to keep their funds in the protocol by depositing them into an extra farming pool. For this, they are rewarded with a greater profit or other inducements, such as voting power in governance decisions. Often, the interest is provided in one or both of the coins the user has chosen to lock up, but it can also be a third-party or protocol-native token.


These separate steps may be done manually or, as platforms become more user-friendly, executed automatically once a user chooses the two assets they wish to farm.

Impermanent loss is one of the complex risks involved with providing funds to liquidity pools, but at the same time, there are greater rewards to be had.

Example

A user goes onto a DEX and provides $200 worth of USDT and $200 worth of Ethereum into a liquidity pool for 18% APY. The user gets a USDT/ETH LP token, and rewards are paid out hourly.

The user then deposits their USDT/NEAR LP tokens into a farming pool, receiving the protocol’s native governance token in return, plus 31% APY, paid out in another native token.

Some of the top DEXes currently used for farming are ones that were already established in or before the last bull market, such as Uniswap, PancakeSwap, Aave, and Curve Finance.

How Does Leveraged Yield Farming Work?

Now that we have a solid understanding of what yield farming actually is, the concept of leveraged farming is easy—it’s the practice of borrowing funds in order to boost the APY return.

The top leveraged yield farming products on the market offer users the ability to borrow anywhere between one and three times their holdings. This means, for example, if you have $100 worth of cryptocurrency, you have the ability to farm with up to $300, receiving the high APY that yield farming can offer.

Let’s take an example from PembRock Finance, a leveraged farming application on NEAR Protocol. Without leveraging (1.0x), we see the coins can be farmed for 45.67% APY.

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If a user is to leverage by 3.0x, however, the maximum the platform allows, they would receive 173.47% APY, even after the borrowing interest is factored in.

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Unless you are dealing with stablecoins, it is impossible to show exactly what someone is likely to receive due to the fluctuating nature of cryptocurrencies. In the PEM/USN case, a rise in NEAR could mean high APY rewards plus a greater position value due to appreciation in the value of the token. A fall in NEAR could mean that returns are eaten into by a fall in the overall value of your position. Of course, as we will explore further in the section on risks, this is still simplifying what is a complex financial process.

Advantages of Leveraged Yield Farming

There are quite a few benefits to leveraged yield farming, including:

  • The potential to receive a much higher return, as discussed above.
  • Additional incentivization such as special lockup programs and token airdrops.
  • Automized farming and reinvestment processes—complex positions can be created in just a few clicks with rewards auto-compounded.
  • The ability to employ different strategies, such as shorting one token while longing another as a hedge against market volatility. This is only possible when leveraging by 2x or more.

What Are the Risks of Leveraged Yield Farming?

We must of course outline the risks involved in farming and leveraging. Rewards are often commensurate with risk, which is why leveraged yield farming can produce losses, especially if danger is countered. Luckily, we are here to address the main risks and how they can be best minimized.

Impermanent Loss

In short, an impermanent loss is often referred to as an opportunity cost and occurs with the automatic rebalancing of funds in a liquidity pool. This phenomenon can be best demonstrated through an example:

  • Liquidity pools must be kept at an even ratio at all times, so let’s imagine we have a NEAR/USDT pool, where $NEAR is worth $5–$1000 invested will give you a 50/50 split in the pool; 500 USDT and 100 NEAR.
  • If the NEAR price goes to $5.50, your NEAR is now worth $550; however, you still have 500 USDT. According to the smart contract, the liquidity pool rebalances itself to ensure the 50/50 split.
  • Some of your NEAR will be taken and exchanged for USDT, with the result being 524.4 USDT and 95.35 NEAR.
    • Here, the opportunity cost is apparent, as you could have walked away with $1050 just by holding, whereas the liquidity pool leaves you with $1048.83, $1.18 less.

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Impermanent loss can indeed be bigger, especially if you are farming a volatile coin.  This means the advice to counter this is very simple—farm reliable coins that aren’t likely to have incredibly wild swings.

It’s also important to note that impermanent loss can be reversed if the coin falls again, and is often seen as a small price to pay when the farming rewards are factored in.

Liquidation

Liquidation is a painful byproduct of borrowing and involves the automatic closure of a position if it is deemed to have an unsustainable amount of debt. The top leveraged yield farming projects are able to lend more than the yield farmer is currently holding due to the liquidation thresholds written into their smart contracts.

If a coin in a farming pair drops to a level where the debt cannot be paid back by a farmer’s initial collateral, the position is automatically closed. This protects those who lend to the platform, as well as the platform itself from taking on someone else’s debt.

While liquidation can involve some big losses to the farmer, many projects allow open positions to be customized, meaning they can add collateral if liquidation seems likely. Then, once again, there is the advice to avoid lightning liquidation by picking coins that don’t tend to randomly rise and fall by huge margins.

Hacks

While becoming more secure as the sector matures, the 2022 report from Chainalysis still shows a worrying level of crypto crime. This means it is a must to make sure that a project has been thoroughly audited, and that the recommendations of the report have been implemented where applicable.

Top Leveraged Yield Farming Projects

While the leveraged yield farming sector is still in its infancy, each major chain has at least one project:

  • Alpaca Finance (BNB Chain)
  • Alpha Homora (multi-chain)
  • Francium(Solana)
  • PembRock Finance (NEAR)

Step-By-Step Guide to Leveraged Yield Farming

For our step-by-step demonstration of how farming with leverage works, we have chosen PembRock, as it takes advantage of the fast, secure, and affordable NEAR blockchain that is extremely user-friendly, and offers great APY on popular farming pool pairs.

Having integrated with Ref Finance DEX, PembRock automates farming positions with up to 3x leverage and really profitable returns are not just provided to farmers (>65% APY on the BTC-wNEAR pair), but also to lenders. Currently, huge APY is being offered to lenders on even extra low-risk cryptocurrencies, such as the stablecoins USDT and USN.

The native token, PEM, allows users to join PembRock DAO through staking and share 100% of the profits made by the protocol. Lastly, PembRock has been audited by BlockSec, ensuring that it is indeed secure to use.

So here’s how you can open a farming position with PembRock in just four steps:

Step 1: Connect your wallet to the PembRockapp.

Step 2: Navigate to the farming section, choose the pair you wish to invest in, and then click Farm.

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Step 3: In the screenshot below, you will see that you can customize your position by picking the coin you wish to deposit, the one you wish to borrow, what percentage of your wallet’s assets you wish to collateralize, and how much leverage you wish to farm with.

All the figures you need to know, such as the farming APR, APY, and borrowing interest are included on the right side of the screen. When you are ready, click the green Farm button at the bottom of the screen.

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Step 4: Monitor your position regularly to see your rewards and reduce your risk of being liquidated. You can close your position at any time and rewards are auto-compounded.

It’s that simple to set up a leveraged yield farming position with PembRock!

What Have We Learnt?

While yield farming and its leveraged counterpart seem difficult, especially to new users, this is not necessarily the case. The top projects automate a lot of the complexity and make things as easy to use as possible for all participants. What’s more, they help to unlock liquidity and bring investment to blockchain ecosystems, which is especially important in bear markets.

As DeFi continues to evolve, we will see more opportunities in this sphere, so stay on top of new developments, and importantly DYOR, making sure that the products you use are indeed trustworthy and offer the functionality and conditions that you are looking for.

To learn more about Yield Farming and PembRock Finance, go to the School of PembRock, which offers information about the project and its roadmap, as well as top DeFi education and leveraged farming tips.

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