In all markets, including decentralized finance, market participants will typically always be in the market for the highest risk-adjusted return on capital. With Rythm, we address the risks associated with yield farming and offer solutions for the risk seekers, the risk averse, and everyone else in between. Leveraged yield farming is one of those solutions Rythm offers, but the following certainly does not constitute financial advice and is simply a summary of Rythm protocol.

Leveraged Yield Farming — Overview

With leveraged yield farming, users can farm with their assets but also borrow against them. This creates the ability for the individuals to increase yields through borrowing assets, all of which are lent out by users who enter a single sided lending pool of that same liquidity pool. These lending pools enable users to decide for themselves which assets they would like to farm with, avoiding the risk of impermanent loss. The decentralized financial ecosystem is ever improving and adjusting, and Rythm is simply another improvement on the current liquidity providing / yield farming category. This article focuses on improvements Rythm makes, so let’s jump into various, but not all, new potential use cases for the protocol.

Leverage For Buying and Holding

Leverage provides the ability for users to take on additional risk by borrowing against their deposit. If a user truly believes in the token pair that they are providing liquidity to, they may also wish to take on additional risk by purchasing and holding the tokens that comprise the pool outside of the pool for price appreciation. Similarly, they may wish to purchase different tokens that aren’t related to the price of their LP tokens at all, as many stablecoin LPs may like to do. Obviously, the key word here is risk. Users who utilize this strategy, along with any other strategy on Rythm, should pay close attention to the liquidation price of their position. Yet, the fact remains users can increase their returns by purchasing tokens, which is a separate source of yield.

Leverage For Airdrops

Another benefit is the ability to participate in a wider variety of airdrops. DeFi has popularized retroactive governance token airdrops to users that have used the protocol in the past. Notable examples include ENS, Uniswap, and SushiSwap, just to name a few of the more high-profile ones. There are a variety of different financial instruments in the DeFi ecosystem that users may want to take advantage of such as on-chain options trading, financial dashboards, and many more. With the ability to leverage LP tokens, a user doesn’t have to suffer from the opportunity cost of removing their LP position order to use different DeFi protocols that may perform airdrops in the future. Indeed — a user could even anticipate such an airdrop, borrow against the value of their LP tokens, and then pay back the accrued debt with the freshly airdropped tokens.

Leverage For Governance Participation

Another use of leveraged liquidity provider positions is the ability to participate in governance without having to sell pooled liquidity for the governance token. For example, imagine an avid DeFi user / liquidity provider missed the Uniswap airdrop and therefore cannot vote on governance decisions that may affect them as an LP. This user would like to participate in governance, but also does not want to leave the pool and miss out on the fee income from their LP position. Instead of removing their liquidity (and subsequently reducing the yield that they could earn), the user could simply borrow against the value of their LP tokens, purchase UNI tokens, and participate in governance. As on-chain governance progresses, this will probably become common and even prove necessary. Especially when Ethereum scaling issues have been solved via PulseChain, as well as EIP-1559 and ETH 2.0 implementations where gas fees are no longer a large prohibitive factor for most users, such a strategy begins to make more sense.

Leverage For Hedging

Another use case of leveraged LP tokens is the ability to hedge positions. If users are providing liquidity to a pair that is not delta-neutral (such as PLS-DAI), they are exposed to impermanent loss and the price movements of PLS relative to the price of DAI when entering the pool. This can create a loss when compared to holding if users need to access liquidity when the position has moved against their long PLS position. With the ability to borrow against the value of LP tokens, a user has the ability to enter into a position that moves counter to the direction of their impermanent loss without the need to put up any more up-front capital. This can help DeFi users counter the high degree of volatility that their portfolios are exposed to while collecting market making fees in the liquidity pool, and in doing so help mitigate liquidity issues and impermanent loss.

Leverage For Arbitrage

One last use-case of leveraged LP tokens is the ability to execute arbitrage trades in order to maintain the price stability of the assets that liquidity has been provided for. This is especially pertinent in the case of stablecoins. Most well-maintained stablecoins should trade 1:1 in most cases. Historically we have seen that this is more or less the case, but not always. In theory, if a user was able to borrow against the value of their stablecoin LP position and an arbitrage opportunity/inefficient market opportunity presented itself, the user would be able to materially affect the relative price of the tokens they are providing liquidity for by trading said pair with the tokens that they borrowed. This combination of stablecoin LPs and the ability to take on leverage could create a virtuous cycle in which the liquidity providers themselves maintain the pegs of various stablecoins in the open market alongside the governance-controlled monetary policy.

Many Strategies, One Protocol

Rythm is a protocol for investors of any risk tolerance. It allows for simple and clean strategies for those who want to set and forget their investments for a period of time, or more complicated strategies that require active maintenance. We encourage all readers to dig deeper and see what strategy could fit their lifestyle and risk profile.

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