'Looping' with NEAR LSDs: DeFi Degen 101

April 17th, 2023

Leverage (aka lending) in DeFi

Defi is composable finance, which means you're able to take different parts of it and assemble them to form your own financial designs. Sometimes people refer to this as 'money legos'

You can use supply and borrow in DeFi to take out short and long positions by using different protocols that allow you to lend and borrow crypto assets with leverage.

A long position is when you expect the asset to increase in value, while a short position is when you expect the asset to decrease in value.

To take a long position, you can supply an asset, borrow a stablecoin, and use the stablecoin to buy more of the asset.
To take a short position, you can supply an asset, borrow another asset that you want to short, and sell the borrowed asset for a stablecoin.
You can then use the stablecoin to repay your debt and keep the difference.

This forms a simple 'loop'. Repeat that loop many times and you've created a larger positions (called leverage) which also carry larger risk.

Looping in DeFi

The looping strategy in DeFi is a process of supplying an asset and borrowing against that same asset continuously to earn a higher yield. This is because some DeFi platforms reward users for both lending and borrowing with their native tokens or other incentives.

By looping, users can increase their exposure to these rewards and earn a positive net APY.

However, looping also involves risks such as liquidation, impermanent loss, and smart contract failures. To use the looping strategy in DeFi, users need to find a platform that supports it, and follow the steps to deposit, borrow, and redeposit the same asset until they reach their desired leverage level.

Looping with LSDs

I think looping works best with LSD (liquid staking derivatives) token but only those who see staking rewards compounded into the LSD token itself.

$NEAR is one of these tokens who's staking program works this way.

The rewards are lower but the risk is substantially lower because:

You're borrowing and lending in the same token so impermeant loss is very unlikely. Not completely though. Whilst LSDs are a one for one exchange for the base token (plus staking rewards) they are still a separate token issued by a protocol and NOT the blockchain token they represent ownership of. Should a protocol get hacked, suffer fraud, or simply be really poorly run you risk losing your funds.
Staking rewards are very reliable and if you balance your funds correctly your positions will gradually pay themselves off over time.

How to Loop liquid staked $NEAR

To start with you want to deposit your collateral in the liquid staked token ($NearX or $stNEAR) because that collateral will grow over time thus increasing your liquidation threshold, essentially helping you pay off the loan.

When you borrow you want to borrow in the base token, in this case $NEAR/$wNEAR. Or the liquid staked version ($stNEAR, $NearX) IF the lend/borrow rates are favourable (see below) and the base token rates are unworkable i.e., borrow rate above the staking rewards.

The reason you probably don't want to borrow in another token (like a stablecoin) is you risk slippage in your loan. Should your collateral be in $stNEAR and your loan be in $DAI and the price of $stNEAR falls, then your liquidation threshold will narrow, as you now have less collateral to your loan.

If the price of your base token rises the opposite effect happens, and you see more upside, but it's much more risky.

Another important factor to consider is the deposit + staked vs borrow rates. In the case here (at time of writing) you get a slightly higher rate on your deposited $stNEAR and $NearX than it costs you to borrow them.

Factor in the staking rewards and you are relatively safe levering up in a like for like position which will pay itself off over time.

Risk Management

Just because this is an automated process doesn’t mean it’s set and forget.

You’ll need to monitor the interest rate spread and the staking rewards as you can see your loans liquidate if deposit + staking returns go down and borrow goes up. This is amplified if you’ve borrowed in a different asset (yet another reason to avoid that).

I'm of the opinion that you should be looking for sustainable long term yields in cryptocurrency and leave the silly "to the moon!" stuff for gamblers (cause that's what it is).

A safer strategy will still see you achieve healthy returns even if the price of the token remains the same or even falls a little.

If the price increases then that's a great bonus, but you don't need price volatility in order to see returns.

Think 2 years, not 2 weeks.

How DeFi survives then thrives

If you are engaged in this industry because you honestly believe in it's ability to reshape finance into a fairer system (as I do) then you know that that will only happen with average returns of ~10%, and will never ever happen with returns of ~1000%.

Volatility is poison to any serious financial products. No one wants to gamble with their core finances so the more ****coins and crypto bros we can chase out of this space the faster we can clean up it's reputation.