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 Go About Getting Leverage?

To obtain leverage in Beraborrow, users can deposit collateral, and use that to mint NECT, then sell that NECT to buy more collateral which is then redeposited into the protocol. This process can be repeated multiple times, allowing users to significantly increase their exposure to the collateral assets. The amount of times users can repeat loop depends on the minimum collateralisation ratio (MCR) for the specific asset. The lower the MCR the more they can 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 Would you use leverage?

1. 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. The degree of leverage used depends on the user’s risk tolerance and conviction in the asset's potential price increase.

2. 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%.

3. Governance: This is rather unconventional (and more of a hypothesis) but due to the nature of the Berachain and how it has aligned validators with the DeFi ecosystem, governance now plays a more important role than ever. And this trickles down to protocols in determining how protocols use PoL. Therefore the accumulation of certain protocols governance tokens will be important to control BGT emissions. So users and protocols could use leverage to increase the amount of certain key governance assets that they hold in order to sway BGT emissions in their favour.

Risks Associated:

• 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.