What is Leveraged Yield Farming? 3 Things You Should Know
Leveraged yield farming is slowly gaining popularity among the yield farmers as it promises higher gains when compared to the regular yield farming practices. Since its inception, the world of decentralized finance is constantly evolving and leveraged yield farming is just another testimonial to this statement. It is a great way to strengthen your roots in the DeFi system and catch hold of your financial position while earning more yields from your existing assets. While this process may be looking very attractive to you, for now, there are equal amounts of risks in it. To familiarize you a bit more with it, here is a guide for you to understand leveraged yield farming better.
What is Leveraged Yield Farming?
Leveraged yield farming is just like regular yield farming. The only difference in the case of leveraged yield farming is that the liquidity provider borrows liquidity from a different liquidity pool. Then they use this liquidity to provide liquidity in a different pool. So, leveraged yield farming is basically borrowing money from a liquidity pool to earn yields from a different liquidity pool and lever your position in it. Now you may get worried about the high-interest rates that are applicable to the money that you borrow from the liquidity pool. But this is exactly where the beauty of leveraged yield farming comes into play. It offers the borrowers the ability to borrow a higher value of money than the value of the collateral they are putting in the pool.
This drives the utilization of the yield farming protocol as well as the money. Also, it gives higher returns to both the farmers as well as the money lenders. This is why more and more investors are trying their hands on leveraged yield farming as the returns, in this case, are considerably higher than the loan amounts and their interest rates. You may now have obtained an idea of what it is all about. Let’s now understand how this process works for money lenders and yield farmers.
How Does Leveraged Yield Farming Work?
Leveraged farming involves three main parties: the liquidity providers, the money lenders, and the money borrowers. Here we have explained the role of each of them in a bit more detail.
Role of Liquidity Providers
Liquidity provides lend crypto assets to the liquidity pool. They are the market makers of the liquidity pool as their absence will lead to a complete halt in the process of leveraged yield farming or even simply yield farming. The liquidity providers earn LP tokens in return for providing liquidity to the pool. These LP tokens help them in earning passive income over their assets locked in a liquidity pool. The rewards are proportional to the share of the liquidity provider in the pool.
Role of Money Lenders
Lending platforms offer collateralized loans to borrowers. This limits the amount of money that the borrower can borrow from the platform. Moneylenders deposit cryptocurrencies in the liquidity pool and earn tokens from the protocol in return. However, the money lenders and the borrowers have to adhere to certain conditions like the availability of a maintenance margin, collateral to take loans, and the value represented by the loan amount.
Role of Borrowers
Leveraged yield farmers or borrowers are the people who borrow tokens or currencies from the liquidity pool. They do so to lever up their position in the liquidity pool. In addition to ramping up their position, leveraged yield farmers or borrowers earn APY rewards for borrowing money from the liquidity pool.
What are the Risks of Leveraged Yield Farming?
Just like regular yield farming, there are some risks involved in leveraged yield farming as well. In fact, the risks involved in leveraged yield farming are pretty much the same as that of regular yield farming. Some of them are given below.
- The smart contracts that govern the working of these protocols may get hacked by hackers with wrong intentions. This may lead you in losing all of your money. You can prevent this loss by choosing platforms which are highly preferred by the yield farmers and are well-known in the industry.
- You may suffer from developer risks. Although there are specialized and experienced developers who write codes for the smart contracts and have very negligible chances of failure. But even though negligible, there are chances of failure or locking of the smart contracts. This may lead to investors losing access to their funds.
- Impermanent losses may happen if one token out of the pair of tokens lent to the liquidity pool decreases in value. This may also lead to the investors losing all of their money in the pool. However, you can prevent this loss from happening to you. To do this, you should for the price ratio between the tokens to return to their original value. Once the original price ratio gets restored, the investor can withdraw their funds from the liquidity pool. Another way of preventing this loss is to stake pairs of stable coins in the liquidity pool. As you may know, stable coins are special cases of cryptocurrencies. Their value remains constant or fluctuates very slightly in a long time.
You may have noticed by now that leveraged yield farming offers a very high potential for investors and borrowers to gain higher APYs through this process. However, it is important to consider the risks equally seriously. Before you get started with a platform, make sure you go through its terms and conditions. In addition, be sure to introduce yourself to the working of the platform. Also, note the APY rewards that they are offering before working with them.