What Is Yield Leverage, And Why Is It Important To DeFi?
In this post we’ll take a look at what it means to leverage LP tokens and why leverage is useful.
What Is Financial Leverage?
Financial leverage involves taking a loan, using the borrowed funds to generate extra profit, then paying back the loan while keeping the extra profit.
A familiar example of leverage happens with home loans. Let’s compare a hypothetical $50,000 stock-investing scenario with a $50,000 home loan scenario to show the difference leverage can make.
Borrowing To Multiply Gains
In the buy-and-hold stock market scenario you start with $50,000 and invest it in the stock market. Fortune smiles on you and your stocks go up 20%. Your investment is now worth $60,000 for a profit of $10,000.
In the second scenario you use your $50,000 as a down payment and take out a home loan for $200,000 to buy a house worth $250,000. Notice that you have leveraged your funds to acquire an asset that is worth 5x your starting investment. Fortune smiles and your home value increases by 20%. Your investment is now worth $300,000, for a profit of $50,000 (less some interest payments). Leverage has multiplied your profits by about 500%.
The Dawn Of DeFi Lending
With a home loan, the lender is willing to lend because he can always take ownership of the house and sell it to pay himself back. The house is the collateral that guarantees the loan can be repaid. How is repayment guaranteed in DeFi, where all parties are unknown to each other?
DeFi lending platforms like Compound and Maker first made it possible to use crypto assets as collateral for permissionless smart contract loans. With a permissionless DeFi loan, the borrower locks up a certain amount of crypto assets as collateral. They then receive the loaned funds to use any way they like.
Liquidation Risk Of DeFi Borrowing
Of course there’s a catch. The lending smart contract is always watching the value of the loaned funds and comparing it to the value of the collateral. If the value of the collateral begins to drop below the value of the loaned funds, the contract hits the brakes and automatically grabs the collateral, allows it to be liquidated, and pays back the lender. That’s bad news for the borrower because they may have been depending on having that collateral in the future. To make matters worse, it may cause the borrower to pay taxes when they didn’t want to. They might even have to sell another investment to raise cash for those taxes. It’s not a good situation. The message here is that careful management of collateral is critical to making DeFi lending work.
The Explosion Of Yield Farming
While DeFi lending services were growing, automated market maker exchanges were exploding, with Uniswap leading the way.
Uniswap lets anyone earn profits by depositing crypto funds into its LP smart contracts. When you do this you become a liquidity provider and your deposits are tracked with LP tokens in your wallet. The profits from liquidity providing mostly come from service fees that users pay when they use Uniswap’s exchange to trade cryptos. (Liquidity providers can also earn other kinds of crypto distributions, such as incentives paid to gain new users.)
This kind of earning is called yield farming, and it’s known for sometimes providing outrageously high returns to LP token holders. Returns of over 1,000% per year caused a mad rush of liquidity providers and added jet fuel to the growth of DeFi in 2020, although these kinds of returns typically don’t last very long.
Impermax unleashes the power of permissionless lending on Uniswap tokens to create leverage in yield farming. If your 10 LP tokens are earning 1,000% interest, you can leverage them 10x so you now hold 100 LP tokens and you’ll effectively earn 10,000% interest (minus lending fees) until such time as you de-leverage (pay back the loan).
Of course, the higher the leverage, the higher the risk that price changes could trigger liquidation. Impermax shows you the exact liquidation price limits before you approve the leverage transaction so you can choose the risk you are comfortable with.
On the lending side, Impermax lets you earn interest from Uniswap with no risk of payment default.
Highest Performance In The Category
Impermax is the best-performing yield leverage platform in DeFi. It allows liquidity providers to easily leverage LP tokens and earn much greater multiples of rewards for the same risk when compared to other platforms.
For example, competitor Alpha Homora allows a maximum of 2.5x leverage on their platform. Their combined lending pools make it very difficult to provide any higher leverage. Impermax keeps all its lending pools separate, allowing Impermax to provide 7x leverage for the same risk level as Alpha Homora’s 2.5x.
If there’s a surge in a certain Uniswap yield, Impermax lets liquidity providers multiply their positions within seconds and exit those positions just as easily. The ability to transfer risk to amplify gains in moments will have a lasting impact on the entire liquidity providing industry. There’s little doubt the liquidity providing industry is still in its infancy, and as it grows, providers will be able to use Impermax whenever they need to tune, adjust, or respond to surging markets.
What do you think? You can leave us your feedback in any of our community channels: