Leverage farming refers to a high-risk, high-reward cryptocurrency yield strategy where users borrow funds to increase their staking positions to amplify returns. Also known as leveraged yield farming, the practice has grown alongside decentralized finance (DeFi) protocols that enable easy access to leverage.
What is Leverage Farming?
Leverage farming involves borrowing stablecoins or other assets from DeFi lending platforms and adding them to liquidity pools on DEXs (decentralized exchanges) in order to increase staking power.
For example, a user with $10,000 worth of ETH could borrow another $10,000 worth of USDC and contribute the total $20,000 to a Uniswap ETH/USDC pool to earn double the normal LP fees and rewards. Or they could directly leverage stake crypto assets using protocol-issued margin tokens.
The amplified yield opportunities come from compounding the staking returns on the borrowed capital. However, leverage equally compounds risk and losses. Users have to overcollateralize their borrowed positions and maintain specific collateral ratios to avoid liquidations.
DeFi Protocols Enabling Leverage
Several DeFi platforms have integrated tools and incentives tailored for leverage farming strategies:
- Aave — Crypto lending platform where users can borrow stablecoins at 5-20% APY to amplify yields.
- Compound — Lending app where supplying assets earns interest and COMP governance token rewards.
- Anchor Protocol — Offers 20% stablecoin savings rate for depositors, making borrowing stablecoins cheap.
- Convex Finance — Boosts lending APYs on platforms like Aave and Curve by distributing platform fee revenue to stakers.
- Liquity — Allows borrowing LUSD stablecoins against ETH collateral at 0% interest.
- Abracadabra — Issues interest-bearing caTokens representing leveraged positions on assets like BTC that can be staked.
Risks of Leverage Farming
While leverage farming can boost APYs to 100% or more, the risks are substantial:
- Liquidations — If collateral ratios drop too low, positions get forcibly liquidated, often at unfavorable slippage rates. This can trigger a spiral of liquidations during crashes.
- Flash loan attacks — Hackers can manipulate asset prices briefly via flash loans to trigger mass liquidations and then buy collateral assets cheaply.
- Impermanent loss — Volatility can drastically impact impermanent loss on leveraged LP positions.
- Platform risk — Smart contract exploits or failures can lead to complete loss of funds.
- Interest rate changes — Spikes in borrowing rates can diminish profit margins.
Due diligence on the leverage protocols used and active position monitoring is essential. Leverage farming rewards often favor larger players with big risk appetites and technical resources.
Leverage Farming Strategies
Those cautiously incorporating leverage can consider tactics like:
- Small position sizes — Keep borrowed positions well below the maximum allowable for a safety buffer.
- Isolated margin — Some protocols allow isolated leverage per position to contain risk.
- Stop losses — Set price alerts and exit points to cut losses if the market moves against borrowers.
- Asset selection — Stablecoin pairs like UST/USDC lower volatility risk versus volatile tokens.
- Farming insurance — Nexus Mutual and InsurAce offer coverage against smart contract risk and exploits.
- Favor fixed rates — Variable rate loans add interest rate risk on top of impermanent loss and liquidation risk.
- Keep collateral diversified — Maintain enough uncorrelated collateral across protocols to prevent cascading liquidations.
When utilized properly, leverage farming can substantially boost DeFi yields. However, the practice sits at the highest end of the cryptocurrency risk spectrum.
The benefits rely entirely on sustained bull market momentum. Caution and prudence is warranted with any leverage strategy. As always, only risk capital that could be entirely lost should be invested using leverage. The magnifying effects work in both directions.