LOOPING IN DEFI
What Is Looping?
As the word suggests, Looping involves investors and traders supplying and borrowing against the same asset multiple times simultaneously, i.e., loop. Every time an asset increases in value, reaching the LTV becomes much more accessible. Unlike longing with liquid cash and other investment techniques, the LTV remains the same during looping. This makes looping a low-risk strategy as it keeps your investment below the LTV radar. With the LTV being the same, one can borrow and supply, i.e., looping, themselves as often as possible. In the long run, your total supply value increases.
If you have been around the Defi space for a while, liquidation is one of the biggest fears for players in the field. It is usually triggered when the LTV (Loan to value) peg is surpassed; this is the ratio between the loaned amount and the asset's value.
This fear of loan liquidation has caused traders and investors to consider options like Yield farming, a low-risk passive income route. Yield farming is investors simply lending their assets out for rewards. But what if an investor or trader wanted more? Another trading technique is; Shorting, which entails getting the opposite of its price movement, i.e., if the asset reduces in value, your debt becomes lower. Then, there is longing with liquid cash, a very high-risk technique. Most investing techniques come with high to medium risk, unlike looping.
Advantages of looping include;
- They are doubling APY and APR without shorting or LTV.
- You can trade your rewards at a swap.
How can it be done?
- Find a lending protocol with incentivized lending.
- Check for the LTV of the preferred assets.
- Employ a loop calculator to know where diminishing returns on your investment are; this determines the number of loops you should take. You get percentage points on the looped cranked-up leveraged value until you are not. Know this point, and stick to it.
- Supply, then lend as many loops.
Because borrowing is incentivizing, you are getting compensated in the native token of your chosen protocol. Once you have started accumulating significant amounts of tokens, it is wise to let it accrue before you claim to beat the transaction fee. Upon claiming, traders can transfer the reward token to their wallets, and then you can swap them for the primary asset you are borrowing and supplying. And the cycle of earning a reward token for your supply/stake continues; rinse and repeat the process.
In the grand scheme of things, you are claiming rewards of staked assets and re-staking them; basically, that is what looping is.
Risks Involved
As much as looping is a low-risk passive income technique, it also comes with its own risk. Some of these are,
- If you don’t continuously compound, you will get liquidated.
- Protocols could pack up in the event of a hack or rug pull
- Risk of liquidation arising from protocol’s bonus tokens not being harvested or converted to the token being looped. This risk is alleviated if everything is on the same token.
- The health ratio will gradually decline even though you are profiting if the interest is not paid off with the incentive reward.
- Although it is highly impossible, one liquidation would decimate all your loops.
- Avoid depositing into automated market makers (AMM), and focus squarely on lending/borrowing from DeFi protocols that allow for intermediaries in tradings.
- Participants could pull their collaterals from the system, which leaves others stranded. Something similar happened during the death spiral of Terra labs.
For every investor, trader, or DeFi enthusiast out there looking for passive investment opportunities, looping is something they should consider.
It should be noted that this article is educational, not financial advice.
Image credits Unsplash
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