What Is Leveraged Yield Farming?

The cryptocurrency market has seen a general uptick in growth, which appears to be providing investors with new possibilities. Also, the way people learn has greatly improved since the advent of the internet. The old-fashioned method of waiting to learn at designated locations is becoming irrelevant as we can learn (virtually anything) without leaving the comfort of our homes; investors and traders can count on getting investment advice or guidance online.

Interestingly, this growth has also been seen in the decentralized finance (DeFi) industry, which is rapidly growing. A high influx of investors, and users have shown interest and investment in the industry.

A recent post by DeFi Pulse shows that there are currently $216 billion in crypto assets invested in the DeFi sector. Digital investing platforms have made investment more accessible than ever. They have also significantly improved the typical investor’s access to the markets, enabling people to participate in things they previously would not have been able to.

One of the primary drivers that have pushed decentralized finance to the spotlight, while creating exponential growth in users is Yield Farming.

Yield Farming is a form of investment that offers investors a decent opportunity to increase their earnings, that’s a common approach that enables investors to earn higher interest rates and maximize returns.

For example, product development that integrates decentralized monetization and other financial processes into applications that are focused on gaming, social networking, music, metaverses, etc can be regarded as a good example of how DeFi is expanding.

In this discussion, we will learn about what leveraged yield farming is, examine how it works, and the advantage of the concept in the crypto industry and its ecosystem. However, we should first start by learning about Yield Farming before delving into Leveraged Yield Farming.

What Is Yield Farming?

The idea of yield farming can be frightening at first, as it is with most things linked to blockchain and cryptocurrencies, however, in this section, we’re going to declutter and explore everything on yield farming.

Basically, the concept behind yield farming is you (the investor) lend your cryptocurrency to the most profitable platforms to earn the highest yields.

More exactly, it is a procedure that enables investors to invest cryptocurrency in a DeFi market and earn either fixed or variable interest.

Also, we can describe Yield Farming as the practice of lending digital cash through the Ethereum network. The idea behind this yield farming concept is the same, which is to earn money and be profitable.

We can identify that on the Ethereum network, yield farming is typically done using ERC-20 tokens, and rewards are also in the tokens. While this might migrate to layer 2 in the future, currently the Ethereum ecosystem hosts the majority of yield farming transactions.

In simple terms, an investor lends his crypto asset to a decentralized finance platform over some time and earns higher returns. The process of staking and lending is known as providing liquidity to the platform, which grants the investor access to daily rewards, otherwise known as APYs.

Further, yield farming is widely accepted in the DeFi industry, and it allows users to communicate with one another using compatible wallets, smart contracts, and an internet connection. Since the dangers aren’t seemingly as great as the profits, there is no issue to “distrust” one another or the farm. But the hazards cannot be ignored, so there’s still a need for caution.

As a result of this, learning the basics of yield farming might seem intimidating for beginners but it’s very crucial to have best practices at your disposal and to always seek professional counsel before entering this new industry.

What Is Leveraged Yield Farming?

Leveraged Yield Farming is an investment strategy where investors/farmers have an added capacity to borrow liquidity and add to their yield farm, to increase profits. It is also a practice to use borrowed funds to pay for farming operations.

A popular advantage is the utilization of uncollateralized loans for investors. This means that they don’t stand to offer collateral as much as what they borrow. This is an opportunity for both farmers and lenders to have higher APYs. Unlike any lending service, you have to pay the interest of the borrowed funds, which in most cases is usually very high, but leveraged yield farming is profitable to carry out this capital strategy as rewards can substantially exceed loan charges.

Furthermore, utilizing borrowed funds to finance a venture is known as leverage, and the rewards generated by DeFi protocols can be increased by yield-farming these cryptocurrencies with leverage. Although, we should note that leveraged trading increases returns and risks for both traditional asset classes and cryptocurrencies.

Leveraged yield farming is a practice to use borrowed funds to pay for farming operations. Farmers can improve their position in yield farming by borrowing external liquidity (currency from liquidity pools) to increase their overall liquidity, which results in a higher return volume.

An investor can boost his revenues by leasing out various assets on the blockchain using smart contracts to optimize profits while yield farming. The fee and interest are paid back to the “farm” in cryptocurrency when the borrower repays the loan.

An Example of Leveraged Yield Farming

A case in point is when you invest with two currencies in a liquidity pool on any decentralized platform. You are typically expected to earn a reward in the form of a token, and a share of the trading fee earned by the farm based on the APY percentage at the time. This share of the trading fee is generated from the interest on loans and trading fees paid by borrowers.

In essence, to earn more, you can go ahead and borrow more tokens which automatically raises your portfolio, and this increase results in more liquidity for you on the farm, more rewards in the form of tokens, and a larger percentage of the trading fee.

From the above example, you earn more in leveraged yield farming compared to yield farming. The ratio is calculated by the amount of liquidity you have invested in the pool proportional to the amount you borrowed. Thus, if your main crypto token amounts to $1000 and you borrowed $2000, it means you have a ratio of 2:1 leverage. It is also important to know that the amount you can loan varies with platforms, tokens, and farms. However, high profit is gained when rewards are higher than the amount you loaned.

Several leveraged yield farming protocols exist, each with distinct features. An example is Alpha Homora, which is popularly known as a leveraging DeFi farming protocol and it’s easy to use, even for a beginner in the crypto space.

Alpha Homora is known for its high leverage ratio of 21 compared to other protocols. The protocol allows users access to higher loans; and relatively high profits.

Breakdown of Leveraged Yield Farming Participants

It is important to note that leveraged yield farming has two primary participants, which are: The lenders that deposit their single tokens within lending pools to earn yields, and farmers that borrow tokens from these lending pools to yield farms with leverage.

Lenders

One of the best yields in DeFi for single assets can be found by lenders in a leveraged yield farming protocol. As previously indicated, a higher overall loan pool enables the maintenance of such high APYs, which is meant by “Utilization.”

The utilization of that pool will be 10% (100/1000) if a lending pool contains 1,000 ETH and some borrowers want to borrow 100 ETH. The advantage of leveraged yield farming and undercollateralized loans is that each borrower can take out considerably more money, leading to higher borrowing utilization.

Farmers

Farmers are also key participants in leveraged yield farming. A user provides liquidity to an automated market maker (AMM) in traditional farming by depositing a pair of tokens in a 50:50 ratio (for example, $100 worth of ETH and $100 worth of USDT).

To manufacture liquidity pool (LP) tokens, this is required. After that, users obtain LP tokens, which over time gain value as trading fees are accumulated into them. To receive additional token incentives, users can also stake some LP tokens in farming pools on decentralized exchanges that offer them.

This points out the fact that leveraged yield farming allows users to enhance their farming positions and hence boost the yields they can harvest. The procedure is straightforward: users deposit any amount of the two tokens into a leveraged yield farming system, and the underlying protocol performs optimal swaps in the background to split the tokens 50:50 for the LP tokens (a process known as Zapping).

Advantages of Leveraged Yield Farming

Leveraged yield farming’s main advantage is that it allows farmers to borrow money beyond the value of the collateral they pledge, which increases returns.

It’s important to know that when price targets are missed, losses are recorded. Trading with leverage and crypto yield farming are activities that are best left for very seasoned investors.

Leveraged yield farming platforms are new but rapidly expanding in DeFi, and projects use a variety of methodologies to bring together protocols, lenders, yield farmers, and liquidity providers to make it possible to borrow and farm tokens in different liquidity pools and reward-generating markets.

Risks of Leveraged Yield Farming

Just as with every other platform, leveraged farming using Alpha Homora comes with liquidation risk. In a real-life situation when an investor borrows from a brokerage to buy stocks, there is a high chance one might lose all assets; the same applies in leveraged yield farming. If the price of your token falls, you also run the risk of losing all your assets to liquidation.

Liquidation is common in a situation where the price ratio of crypto assets within the pool changes, primarily the assets borrowed or lent. For instance, when you set up leverage, borrowing about 4x the initial funds you invest, whichever protocol you employ has the responsibility of ensuring that you pay back that loan.

Therefore, your main fund becomes the collateral which also accumulates as your yields grow. This collateral has to be retained to stay above the amount you owe, otherwise, the protocol would have to dissolve your position, and this process is known as liquidation.

In essence, the frequency at which the price ratio fluctuates from the initial cost is also the rate of the loss to be incurred. This however can be salvaged if the main price ratio is restored, which is quite uncommon.

To avoid liquidation, below are a few things you can do.

• Always keep close tabs on your “Safety Buffer,” this will indicate whether or not you are close to liquidation. Once the safety buffer gets to zero, you are up for liquidation and this is so because your main asset has dropped significantly in price, as explained above.
• Once you notice a drop in your Safety Buffer, you should add collateral to increase the Safety Buffer.
• Ensure you play safe about farming; it is safe to farm stablecoins. In this case, liquidation is quite unlikely.

Yield Farming Ecosystem

Currently, there are various approaches to producing maximum returns due to the variety of crypto yield farming techniques and the quick rate of development results in an ecosystem that is continuously changing, necessitating a continuous evaluation of the potential for cultivating DeFi output.

The list below, while not exhaustive, comprises some of the main yield farming platforms.

• Aave: This is a non-custodial, open-source, decentralized lending and borrowing protocol. AAVE tokens are used by users to construct money markets, borrow assets, and earn compound interest.
• Compound: A money market protocol that allows for algorithmically modified compound interest rates to be used for cryptocurrency borrowing and lending. By using the protocol, users can also earn COMP governance tokens.
• Curve Finance: A DEX technology that permits users to trade stablecoins and other decentralized protocols. Low costs and little slippage are guaranteed by the Curve protocol, which employs a special market-making algorithm.
• Uniswap: The Uniswap is a DEX and AMM that promotes the swapping of over 70% of any ERC-20 token pair.
• PancakeSwap: This also is a DEX and AMM on the Binance Smart Chain (BSC) that allows traders to use the BEP-20 tokens.
• Venus Protocol: This is a money-market platform based on algorithms that incorporates BSC’s credit and lending systems.
• Balancer: A portfolio manager and automated trader that uses flexible staking as its liquidity protocol.
• Yearn Finance: A user-generated algorithm that finds successful crypto yield farming services through a decentralized, automated aggregation mechanism.

Steps on how to Leverage Yield Farming

• The first step involves funds being deposited into a liquidity pool by Liquidity Providers (LPs).
• These deposited funds mostly are ETH and stablecoins that are linked to USD, such as DAI, USDT, USDC, and more.
• In terms of returns, this would be determined by the terms of the protocol you have an investment with and the amount you invest.

Leveraged yield farming amplifies exposure to a strategy that influences the size of the equity, increasing yield farming gains, and minimizing the downside in case of liquidation. These borrowing assets leveraged by yield farming allow them to multiply their initial position or follow different strategies based on where they think market values are going.

Yield Farming in Crypto: DeFi Liquidity Mining Strategies

A yield farming method is frequently established by acting as an LP, however, their LP tokens are maximized by being staked into numerous protocols and pools.

Liquidity providers are not legitimate yield farmers and liquidity miners frequently deposit tokens into various liquidity pools and DEX systems. This kind of staking or farming possibility abounds in the DeFi liquidity mining market, and new pools and protocols appear regularly.

Cryptocurrency yield farmers can stake their LP tokens for as long as they like, from a few days to several months, in a variety of protocols and liquidity pools.

Staking Crypto Vs. Leveraged Yield Farming

Some people wrongly use the terms yield farming and crypto staking interchangeably, not knowing they are two different procedures. Yield farming, also known as liquidity mining, is a way to earn rewards using your cryptocurrency holdings.

On the other hand, the main use of staking is as a component of the Proof-of-Stake (PoS) blockchain’s consensus mechanism, for which stakers also receive incentives. Staking produces a return, but it is often substantially smaller compared to using DeFi yield farming techniques.

Staking yields typically pay out once a year and range from 5% to 15%. Compared to this, leveraged yield farming rates in cryptocurrency liquidity pools can reach 100% or more, and payout continuously, enabling withdrawals at any moment.

Leveraged yield farming is, however, riskier than staking even though it is more profitable. For instance, the network gas prices necessary to collect rewards when yield farming on Ethereum can lower revenues from APY rates.

In addition, a temporary loss might happen and significantly lower profitability if the market gets volatile in either direction. When this happens, the value of tokens stored in a liquidity pool with an algorithmic balance starts to decline with assets on the open market.

But, the adoption of smart contracts by liquidity pools further increases the possibility that hackers will discover and use flaws in the underlying system.

Conclusion

Leveraged yield farming is considerably the ‘next big thing’ in yield farming due to its greater returns which also serves as a major point of attraction. It is, however, important to stress that, just like any other type of investment, it holds risks. Of other potential risk factors, the possibility of price change holds a greater risk which would eventually lead to assets liquidation.

Notwithstanding your level of expertise within the cryptocurrency space, you must tread with caution when carrying out leveraged yield farming and put-up structures that could avoid the risk and probably reduce the impact. One such precautionary measure is to set the minimum and maximum limits to asset fluctuations.