Leverage in Beraborrow
What is Leverage?
Leverage is the use of external capital to increase exposure to a specific asset or to amplify the position size in a trade. This enables users to potentially make outsized returns compared to the initial capital they started with. However, leverage is a double-edged sword. While it can magnify gains, it also comes with increased risk. The borrowed capital must always be covered by the value of the position to ensure that the position can be liquidated, and no bad debt is incurred by the lender.
How do I get Leverage?
To achieve leverage in Beraborrow, users employ recursive borrowing and lending. This involves depositing collateral to mint $NECT, selling the $NECT to acquire additional collateral, and redepositing it into the protocol. This cycle can be repeated multiple times, enabling users to amplify their exposure to the collateral assets. The extent to which this process can be repeated is determined by the minimum collateralization ratio (MCR) of the specific asset—the lower the MCR, the greater the potential leverage.
However, this process can be tedious and incurs high gas fees due to multiple transactions required for each loop. Flash loans can solve this problem by allowing users to perform these steps in a single transaction, read more here.
Why use Leverage?
Price Speculation: If a user is long on a specific asset, meaning they believe the asset's value will appreciate over time, they might use leverage to amplify their exposure. Meaning that their gain or loss will be proportional to the amount of leverage they used. Eg. a user that uses can use 5x leverage to 5x their potential upside.
Yield Boost: In the case that a user holds an asset for its return rather than price appreciation, leverage can be used to significantly increase these returns. For example, if an asset yields a 12% APR from staking, using leverage can increase exposure to this asset, thereby increasing the yield. A user leveraging 3x could increase their effective yield from 12% to 36%.
Governance: Berachain’s alignment of validators with the DeFi ecosystem makes governance more pivotal than ever, especially in shaping how protocols utilize PoL. Accumulating key governance tokens is essential to influence BGT emissions. Both users and protocols may focus on increasing their holdings of these assets to sway emissions in their favor...
Risks Associated with Leverage:
Total Loss of Collateral: If the collateral value falls below the required threshold, the protocol will automatically liquidate the collateral to cover the loan. This means users could lose all their collateral if the market moves against their position.
Increased Volatility Risk: Leveraged positions are more sensitive to price movements. A small decrease in the asset's price could trigger liquidation, resulting in significant losses.
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