Crypto Day Trading: Leveraged Yield Farming Strategies

Does leveraged yield farming sound intimidating? It’s understandable that some would feel that way. After all, leverage and yield strategies are tools that professional investors have been known to utilize, their inner workings esoteric to the every-day investor. Yet, with the growth of decentralized finance, that’s no longer the case. Easy-to-use platforms now exist to allow normal investors to take advantage of these tools and earn yields that even professional investors can’t beat.

Of course, for professional investors, it’s also a positive situation. With these tools, they can further customize their strategies to perfectly align with their market biases, risk profiles, and target yields. And all this while participating in the high-growth high-yield sector of decentralized finance.

So let’s break down leveraged yield farming strategies step-by-step.

What is leverage?

Leverage results from using borrowed funds to expand your capital base and the potential returns on that capital base. In other words, you borrow funds so you can invest more, and as a result — earn more.

What is yield farming?

Yield farming is the innovative DeFi concept where users stake or lend their crypto assets in order to receive returns.

Combine the two, and you have leveraged yield farming!

In the context of yield farming, leverage involves borrowing assets to multiply your yield farming position, resulting in you accruing larger yields.

Since leverage requires borrowing, then naturally, there is a counterparty acting as a lender. Thus, each leverage yield farming platform consists of lenders and borrowers(farmers). For the casual user, participating in leveraged yield farming often starts with simple lending, which typically provides higher APYs than other lending platforms because leveraged yield farming has greater capital efficiency.

However, participating in leveraged yield farming as a farmer is not difficult either. In fact, it can be as simple as creating a position in one click! For more advanced and professional users, there are also many interesting strategies available to customize positions based on market outlook.

Those comfortable with options will understand how certain strategies can be used to tailor to the user’s needs. For example, in option theory, if someone was bearish but they wanted to limit their risk and not simply buy a put option, they could buy a put and sell a cheaper put to limit their risk, this strategy is called a put spread. Leveraged Yield Farming is powerful because it allows for this kind of tailored approach to yield farming and crypto assets exposure.

Here are the primary strategies that users employ on leveraged yield farming protocols and the reasons why these may be attractive strategies for you.

Strategy 1: Holding With Leveraged Yields

If you plan to hold a token but don’t like the idea of leverage, you can consider farming at 2x leverage, borrowing the token opposite your held token. For example, if you hold $10,000 worth of ETH, you can farm ETH-USDT at 2x leverage by borrowing $10,000 worth of USDT; or, farm ETH-BNB at 2x leverage by borrowing $10,000 worth of BNB. You are “holding with leveraged yields” because you actually have not leveraged up the exposure to your holding asset, but you will be earning 2x leveraged farming yields. When you stop farming, you simply return the borrowed tokens.

However, by earning this additional yield, you do assume some risk of impermanent loss (IL). The graph below shows how your equity will change when the price of ETH (the non-borrowed token) changes. When holding ETH in your wallet (dotted black line in figure below), your equity linearly correlates with ETH price. When farming an ETH-token pair without considering yields (solid black line), your equity is worse off than if you had just held ETH (which is commonly known as impermanent loss). However, when considering the 2x farming yields you’d be receiving over time(green line), your profits compared to simply holding would be higher in total if the held token did not appreciate significantly over a short period. Therefore, leveraged yield farming is best used as a long-term strategy.

If you farm a token pair with ETH and a non-stablecoin at 2x leverage (borrowing the non-stablecoin), changes in price of the borrowed token will also result in some impermanent loss (blue line = +25% change in borrowed token; red line = -25% change in borrowed token). But, again, the earned 2x yields over time oftentimes make up for this. (You can play with these models and emulate your profit/losses on a publicly available Yield Farming Emulator and Calculator from Alpaca Finance.)

*Colored lines assume yield farming APR + trading fees APR at 1x leverage of 25%, borrowing interest APR of 15%, platform rewards APR of 10%, and a 90-day farming duration.

Strategy 2: Leveraged Long

If you are confidently bullish on a token (e.g., ETH), you can consider farming an ETH-token pair at >2x leverage, borrowing the token opposite ETH. By doing that, you will be leveraged long on ETH. For example, if you hold $10,000 worth of ETH, you can farm ETH-USDT at 3x leverage, borrowing $20,000 worth of USDT. $5000 worth of USDT will be swapped for ETH to make a 50:50 farming pair ($15,000 worth of ETH + $15,000 worth of USDT). In this situation, at 3x leverage, you will be 1.5x leveraged long on ETH.

You can also farm an ETH-(non-stablecoin) pair like ETH-BNB at 3x leverage, borrowing $20,000 worth of BNB. Again, $5000 worth of BNB will be swapped for ETH to make a 50:50 farming pair. But because $5000 worth of the borrowed BNB is sold, you will have a small short position on BNB. Whenever you use >2x leverage, you will have a slight short position on the borrowed token, which gives you extra options in customizing your position. Of course, if you don’t want to worry about shorting, you can borrow a stablecoin which is effectively neutral since the price can be reliably expected to maintain its stable peg.

The graph below shows how your equity will change when ETH (the non-borrowed token) or the borrowed token (either USDT or BNB) changes. Compared to simply holding ETH (dotted black line), your equity without considering yields (solid black line) will outperform when ETH rises because you’d be 1.5x leveraged on ETH; when considering yields (green line), your profits would be even greater. If the borrowed token price rises, you’d lose equity (red line) because you have a slight short on it. And if it drops, you actually profit (blue line).

*Colored lines assume yield farming APR + trading fees APR at 1x leverage of 25%, borrowing interest APR of 15%, platform rewards APR of 10%, and a 90-day farming duration.

Strategy 3: Shorting

In Strategy 2, you might have noticed that leveraged yield farming can be used to short for a profit. Thus, if you believe ETH will fall, you can short ETH by farming an ETH-stablecoin pair while borrowing the token you want to short (ETH) at >2x leverage. For example, you could open an ETH-USDT position, depositing $10,000 worth of USDT, and borrowing $20,000 worth of ETH (3x leverage). $5000 worth of ETH would be swapped for USDT to create a 50:50 farming position ($15,000 worth of ETH + $15,000 worth of USDT). As such, you’d essentially have a short position on ETH worth $5000 worth.

The graph below shows how your equity would change when the price of ETH (the borrowed asset) moves. Compared to not farming (dotted block line), your 3x leveraged farming position (without considering yields, black line) would profit when ETH falls. (However, once ETH dropped ~50%, your ETH position would shift from short to neutral due to asset rebalancing from the AMM, and any further price drop in ETH would then shift your position into a long, making you take a loss if ETH’s price continued to drop. This is something you would want to keep in mind if price moved significantly.) In addition to gains from the short, when considering yields (green line), your profits would be even higher.

*Green line assumes yield farming APR + trading fees APR at 1x leverage of 25%, borrowing interest APR of 15%, platform rewards APR of 10%, and a 90-day farming duration.

Strategy 4: Hedged Market-Neutral

If you are conservative, you could create positions where you’d have neutral or near neutral exposure to the volatile crypto market, while still capturing gains from yield farming.

The simplest method to have zero market exposure is to leveraged farm stablecoin-stablecoin pairs (up to 6x leverage) to earn up to 50% APY, which is among the highest yield for stablecoins across all DeFi chains.

In addition, there are two other methods to capture even higher yields while maintaining near neutral exposure to the crypto markets. They involve farming crypto-stablecoin pairs such as ETH-USDT, which generally have higher APYs than stablecoin-stablecoin pairs.

The first method (similar to Strategy 1) is quite simple: if the BNB-BUSD farming yield is looking attractive, you could deposit the stablecoin (BUSD) and borrow the volatile asset (BNB) at 2x leverage. You’d have zero crypto exposure at position opening (although it could shift through asset rebalancing if BNB price moved), while capturing 2x farming yields.

The second method combines Strategy 2 and 3. You’d create two positions: (1) a leveraged long position on a crypto asset and (2) a short position on the same asset. Then, in aggregate, their exposures would cancel out. We call this pseudo delta-neutral because it is a delta neutral strategy, but LP rebalancing will slightly move your position away from true neutral as prices shift, which may require some management to keep the positions neutral.

Let’s use the ETH-USDT farm (using 3x leverage) to give an example setup. For Position#1 (using Strategy 2), deposit $10,000 worth of tokens and borrow $20,000 worth of USDT (3x leverage) – you will be farming $15,000 ETH + $15,000 USDT and you will be long on $15,000 worth of ETH.

For Position#2 (using Strategy 3), deposit $30,000 worth of tokens and borrow $60,000 worth of ETH (3x leverage) – you will be farming $45,000 ETH + $45,000 USDT and you will be short on $15,000 worth of ETH. The two positions’ exposures on ETH would cancel out and you’d be earning 3x yields on $40,000 with near-neutral market exposure.

The graph below shows how your equity would change when the price of ETH (the asset token) moves. Without considering yields (black line), if ETH price changed, you’d lose equity due to LP rebalancing(impermanent loss). When considering yields over time though, you will generally see profits. For the first method (one position at 2x leverage), the curve is flatter and broader than the second method (two positions at 3x leverage); you don’t earn as much, but the position is a bit more resilient to ETH price changes. For both methods, only large changes in ETH price would negatively affect your equity. To many, pseudo-delta neutral strategies offer gains that outweigh the risks and may be preferred over farming stable-stablecoin pairs.

*Colored lines assume yield farming APR + trading fees APR at 1x leverage of 25%, borrowing interest APR of 15%, platform rewards APR of 10%, and a 90-day farming duration.

Conclusion

As the above strategies demonstrate, leveraged yield farming is a flexible tool which can accommodate a variety of trading strategies and market conditions. So regardless of if you’re bullish, bearish or uncertain, and whether you’re considering taking a position on a particular token or the market as a whole, leveraged yield farming can help you customize your position and earn high yields in almost any setup.

Dr.Brian Huang was a research assistant professor at China Medical University in Taiwan before turning to entrepreneurship and blockchain development.