Big Brain DeFi Yield Farming Strategies (Part 1 of 2)
In our previous yield farming article, we discussed a few different basic strategies depending on your farming stack and risk tolerance.
In this series, we’re going to reveal additional advanced yield farming strategies often used by DeFi whales with the goal of increasing your yields while protecting yourself from price volatility:
- Rehypothecation on lending platforms
- Borrowing volatile assets to farm
As always, the most important thing when staking in these contracts is making sure you’re not going to get rugged. Make sure to do your research to verify the legitimacy of the project and safety of the contracts.
Don’t get seduced by attractive APRs that you over leverage and risk losing it all to a rug or exploit. Just like trading, we never go all into one farm. We like to spread our risk over 3–4 different farms to mitigate risk.
Rehypothecation
In traditional finance, Rehypothecation is a process where a bank uses assets that have been posted as collateral by their clients.
In DeFi, it means to supply assets to a lending protocol (like Compound, AAVE, etc.), take a loan against it, then resupply the loan and re-borrow up to virtually infinite amount of times.
Essentially this allows you to leverage your staked assets to earn yield on a much principle. If you do this with the same asset (ie supply USDC, borrow USDC), then you have near-zero liquidation risk because your loan-to-value (LTV) ratio will always remain the same.
This strategy works with protocols that pay you incentives for using them. Like when AAVE first launched on Polygon, you would get $MATIC rewards just for lending and borrowing. Usually, the APR from these rewards is greater than your borrow APR, so they are essentially paying you to borrow!
Let’s walk through an example of this on the https://drops.co platform:
Let’s use WBTC for example. You earn a base 0.78% APR for supplying wBTC which is pretty meh. But if you take into account the $DOP rewards you’ll also receive, you’ll earn 13.97% net APR.
If you were to borrow WBTC, you would owe 2.05% APR as a base rate. But taking the $DOP rewards into account, you would earn 31.1% APR net. Essentially, Drops is rewarding you with their $DOP governance token as an incentive for using their lending platform.
If you were to use this the “normal” way, you would perhaps supply USDC at 11.55% APR and borrow WBTC at 31.1% APR. You would then monitor your LTV (loan to value ratio) to make sure you have enough collateral to keep your loan healthy (ie. if BTC pumps too much, you risk getting liquidated).
Most lending platforms let you borrow 60–80% of your collateral. So let’s say you supply $100k USDC, and borrow $70k wBTC (70% LTV).
Your effective yield if you were to supply and borrow the normal way would be:
- Principal: $100k USDC
- Yield on USDC Supply: 11.55%
- Yield on BTC Borrow: 31.1*0.7 = 21.77%
Your total yield is 33% on USDC which is pretty good, but you risk is liquidation if BTC pumps.
We can get more creative with the strategy here to boost our yield via rehypothecation:
- We start by supplying $100k of USDC as normal
- Then we borrow $70k of USDC
- Then we resupply the $70k of USDC
- Then we borrow $49k of USDC
- Then we resupply $49k of USDC
And so on…
We can do this numerous times to lever up 3x until we have $300k of USDC supplied and $210k of USDC borrowed.
That would give us an effective yield of:
- Principle: $100k USDC
- Supply: 11.5% * 3 = 34.5%
- Borrow: (0.7) * 18.88% * 3 = 39.64%
So your total APR on $100k of USDC becomes ~74.4%.
And that’s just on the $USDC which has lower reward rates. If you did this with $100k of WBTC instead, you would earn ~107% APR. As far as we know, there’s no where else where you can earn that type of yield on BTC.
Risks
As mentioned earlier, with yield farming, you need to be aware of all the risks before aping funds. These are the risks to be aware of with this particular strategy:
- Rug or exploit risk — This should be pretty obvious. Be careful with new protocols that haven’t been around for long. Because you are re-supply your borrowed funds, if something bad happens, you could lose everything (as opposed to only your collateral if you took. out a loan the normal way)
- Liquidation risk — If your debt grows too high (due to accrued interest on the borrow side), then still you risk getting liquidated, even when supplying/borrowing the same assets. It takes a long time for this to happen since the borrow APRs are usually very minimal. However, this is why we like to borrow less than the limit (ie. if borrow limit is 80%, we will only borrow 75%). To avoid liquidation risk, simply just repay your borrow or stake additional collateral with your farmed rewards often.
- Gas fees — It can get expensive supplying/borrowing back and forth if you’re doing this on ETH, but a few days of yields should more than make up for the gas costs
Lending Protocols
Right now, you can use this strategy on:
- KeperDAO Hiding Vaults, which is built on top of Compound and pays ROOK reward tokens
- Drops, a lending platform and soon NFT staking protocol that rewards
- Mensa, a lending platform on FTM
Soon, AAVE will launch on Avalanch network and you’ll be able to use the strategy there as well, since they will have millions of incentive rewards for users.
That’s it for this strategy. We hope it opened your mind to more creative yield farming strategies. In the next article, we’ll look at how to leverage borrowing assets to get higher yields with reduced volatility.
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