What Is the Cost of “Infinite Leverage”?

Infinity Pools introduces the concept of “infinite leverage” and creates great marketing around it, but what it really is?

If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck.

It’s best to understand it via an example. It all starts with Uniswap v3 LP position. For illustration purposes, we take into account ETH/USDC pair and assume that the current ETH price is 1000 USDC. Further, assume there is an LP who deposits 1000 USDC to the pool and decides to concentrate the liquidity around 950 USDC i.e. posts a limit order to buy ETH at 950 USDC.

Here, Infinity Pools comes in and offers a market for lending and borrowing LP tokens. A speculator could borrow Uni v3 LP token, redeem the underlying 1000 USDC and purchase ETH on the market (for simplicity assume no slippage, price impact or transaction fees).

In addition, the difference between the ETH market price of 1000 USDC and LP’s limit order of 950 USDC would have to be deposited as collateral by the trader.

There are three main scenarios in which we need to understand implications:

1. ETH trading above 1000 USDC e.g. if ETH goes to 2000 USDC, the trader closes the position at a profit and returns 1LP token worth 1000 USDC back to the lender.
2. ETH trading between 950 and 1000 USDC e.g. if ETH goes to 960 USDC, the trader needs to top up the difference of 40 USDC in order to return 1000 USDC back to the lender.
3. ETH trading below 950 USDC e.g. if ETH goes to 800 USDC, the lender is expecting to receive ~1.05 ETH (1000/950). Trader already holds 1 ETH (minus slippage and fees) and 50 USDC as collateral. The collateral is now worth 0.0625 ETH, thus total position size is 1.115 ETH which is larger than the debt.

The leverage is derived from the amount of collateral that is deposited by the trader and the total position size, in the example above the implied leverage is 20x.

While intellectually interesting, this type of product is essentially a call option with some modifications. This is best illustrated when visualizing the payoff of both LP and trader:

LP perspective

The position can be replicated in two ways: 1) invest in risk-free rates or lend money and short put at a $950 strike price or, 2) covered call: long ETH and sell a call at a $950 strike price. The mental model of Infinity Pool LP is more similar to 1).

Trader perspective

The trader position would be similar to a long ETH call at a strike of $950.

However, why there is even a need for the buyer to post collateral when we showed that the trader is simply buying call options?

Because of a mismatch between counterparties. The closer the LP strike price is to the current price of ETH, the less collateral it requires. For instance, if the liquidity range borrowed was deployed at 999 USDC, the initial collateral required would be 1 USDC (1000x ‘leverage’).

The requirement for a trader to deposit collateral is therefore capital inefficiency due to the market mismatch. An at-the-money call option would essentially be the “infinite leverage” with 0 collateral required. Yet, in our example, the trader is replicating an in-the-money call.

So how much would it cost to use Infinity Pools?

For our example, the cost for the trader for opening such a position should be ~$97:

• ~$43.5 should go to the LP for the underwriting of the put position
• ~$50 should go as collateral
• ~$3.5 should be the borrowing cost

Overall, Infinity Pools is a sophisticated concept and it would be interesting to see whether it manages to find PMF after so many option protocols failed to gain meaningful traction.

Would you be willing to pay for the “infinite leverage”?

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