Unlocking DeFi 2.0: The Degen’s Guide to Lending & Borrowing Strategies

As a lending and borrowing protocol built on the Hedera network, Bonzo Finance is helping usher in DeFi 2.0 — reshaping the way Hedera users transact and utilize their digital assets, while contributing to the overall health and adoption of the ecosystem. Based on the battle-tested Aave v2 protocol, Bonzo Finance offers a robust, efficient, and user-friendly lending & borrowing experience for Hedera ecosystem users.

In this blog post, we'll dive into DeFi lending & borrowing strategies that are commonly used by retail and institutional traders across web3 — from simple lending for passive income to complex recursive borrowing and leveraged yield farming techniques. We'll cover a range of approaches suitable for both newcomers and experienced DeFi users.

⚠️ Disclaimer ⚠️
The strategies and information presented in this blog post are for educational purposes only and do not constitute financial advice. DeFi strategies, including those discussed here, involve significant risks, including but not limited to smart contract vulnerabilities, market volatility, liquidation risks, and potential loss of funds.

Bonzo Finance does not endorse or recommend any particular investment strategy. Users should conduct their own research, understand the risks involved, and consult with a qualified financial advisor before making any investment decisions.

Cryptocurrency markets are highly volatile and unregulated in many jurisdictions. Past performance is not indicative of future results. Never invest more than you can afford to lose, and always be aware of your local laws and tax implications when participating in DeFi activities.

The examples provided are purely illustrative and may not reflect current market conditions or protocol parameters. Always verify the latest information directly from official sources before executing any DeFi strategy. By using Bonzo Finance or implementing any strategies discussed in this post, you acknowledge and accept all associated risks.

A Brief Overview of Bonzo Finance

Bonzo Finance is an open-source, non-custodial lending and borrowing protocol that enables users to supply cryptocurrencies to earn interest and borrow against their holdings. Bonzo supports a wide range of assets, including HBAR, HBARX, hUSDC, SAUCE, XSAUCE, DOVU, and KARATE, with more supported assets on the way. With a focus on security, transparency, and community governance, Bonzo Finance is set to become the liquidity layer of the Hedera DeFi ecosystem.

Simple Strategies: Earn Yield, Borrow Liquidity, & Leveraged Trading

These basic strategies provide a solid foundation for using decentralized lending & borrowing protocols. As you become more comfortable with these concepts, you can explore more advanced techniques to potentially enhance returns and optimize capital efficiency.

Yield Farming

Lending is the most straightforward way to earn passive income (yield) on your crypto holdings — unlike decentralized exchange (DEXs), all liquidity pools consist of a single asset and do not experience impermanent loss.

• Supply assets: Deposit any supported asset into its liquidity pool on your chosen lending protocol.
• Earn interest: Supplied assets start earning interest immediately, with rates that adjust based on market demand.
• Compound returns: Interest accrues continuously and is added to your supplied balance, allowing for compound growth.
• Flexibility: Withdraw your assets at any time, subject to pool liquidity.

Real-World Example

If you supply 10,000 HBAR at an APY of 5%, you could earn approximately 500 HBAR in a year, assuming stable rates.

Pro Tip Keep an eye on interest rates across different assets to optimize your lending strategy. Rates can vary significantly between stablecoins and volatile assets.

Borrowing for Short-Term Liquidity

After collateralizing (supplying) any assets to a decentralized lending protocol, borrowing allows you to access liquidity without selling them, which can be useful for various purposes:

1. Provide collateral: Deposit supported assets as collateral. The amount you can borrow depends on your collateral's value and the asset's loan-to-value (LTV) ratio.
2. Select an asset to borrow: Choose any asset that is supported by your chosen protocol.
3. Receive borrowed assets: The borrowed funds are transferred to your wallet immediately and interest starts to accrue.
4. Repay the loan: Return the borrowed amount plus interest at any time.

Benefits of Borrowing for Short-Term Liquidity

• Cover unexpected expenses without selling your long-term holdings
• Take advantage of short-term investment opportunities in various assets
• Manage cash flow for personal or business needs
• You hold 5,000 HBAR but need $1,000 USDC for a short-term expense. Instead of selling HBAR, you can use it as collateral to borrow USDC, preserving your HBAR position.

Real-World Example

You hold 5,000 HBAR but need $1,000 USDC for a short-term expense. Instead of selling HBAR, you can use it as collateral to borrow USDC, preserving your HBAR position.

Leveraged Borrowing for Increased Exposure

Leverage allows you to increase your exposure to an asset without committing additional capital. Here's how to perform a basic leveraged position:

1. Deposit an asset (e.g., HBAR) into its liquidity pool.

2. Use your deposited HBAR as collateral to borrow more HBAR.

3. Supply the borrowed HBAR back into the protocol and borrow again.

4. Monitor your position and keep an eye on your health factor to avoid liquidation — do not allow your health factor to drop below 1.

Real-World Example | 2x Leveraged HBAR Position

• Initial deposit of 1,000 HBAR
• Borrow 500 HBAR — assuming a 50% Loan-to-Value Ratio (LTV)
• Total exposure: 1,500 HBAR having only supplied 1,000 HBAR as collateral

Risks

• Higher exposure to price volatility
• Potential for liquidation if the collateral value drops
• Interest costs on borrowed amounts

Intermediate Strategies: DEX Yield Farming, In-dApp Asset Utility, & Debt Refinancing

As you become more comfortable with basic lending and borrowing, it's time to explore more sophisticated strategies that can potentially enhance your returns and capital efficiency. Let's dive into some intermediate DeFi strategies you can implement using decentralized lending protocols.

DEX Yield Farming with Borrowed Assets

Yield farming involves leveraging borrowed assets to earn additional yields across various DeFi protocols, such as decentralized exchanges. Here's how to use decentralized lending protocols for this strategy:

1. Supply assets as collateral: Deposit a stable asset (e.g., USDC) into its associated liquidity pool on your lending protocol of choice.

2. Borrow against your collateral: Take out a loan in another asset (e.g., HBAR).

3. Use borrowed assets for yield farming: Deposit the borrowed HBAR into a liquidity pool or staking platform offering high APY.

4. Monitor and rebalance: Keep an eye on interest rates, yields, and your collateral ratio.

Real-World Example | DEX Yield Farming

1. Deposit 10,000 USDC as collateral into liquidity pools

2. Borrow 80,000 HBAR — assumes 80% loan-to-value (LTV) ratio & $HBAR price of 10¢

3. Deposit borrowed HBAR on a decentralized exchange liquidity pool

4. Net profit = Yield on USDC deposit (+) Yield on HBAR deposit on DEX (-) HBAR borrowing rate interest

Risks

• Impermanent loss in liquidity pools
• Changes in borrowing rates or farming yields
• Potential liquidation if collateral value decreases

Pro Tip Diversify your yield farming strategies across different assets and platforms to minimize risk and maximize potential returns.

Borrow Assets to Use in dApps

This strategy involves borrowing specific tokens from a decentralized lending protocol to utilize them in their native applications, potentially earning additional rewards or benefits. Here's how this can be performed:

1. Identify opportunities: Research tokens available that have utility in applications across the ecosystem.

2. Borrow the target asset: Deposit collateral to the lending protocol in order to borrow the desired token.

3. Utilize the borrowed tokens: Transfer the borrowed assets received to its native application and use them for their intended purpose.

4. Collect rewards: Earn additional tokens or benefits from the native application.

5. Repay the loan: Return the borrowed amount plus interest, ideally with profits earned from the strategy.

Real-World Example | Borrow KARATE for In-dApp Betting

1. Deposit any supported asset as collateral into the lending protocol.

2. Take out a loan of KARATE tokens based on your collateral.

3. Move the borrowed KARATE tokens into your account / wallet in the Karate Combat application.

4. Participate in no-lose betting by using the borrowed KARATE tokens to bet on fighters in their no-lose bet system.

5. Earn rewards by collecting additional KARATE tokens from successful bets.

6. Repay the borrowed KARATE loan with interest and keep the extra tokens earned as profit.

Risks

• Interest costs on the borrowed assets
• Potential for liquidation if the value of your collateral decreases
• Application-specific risks (e.g., betting outcomes, smart contract vulnerabilities)
• Volatility in the borrowed asset's value

Pro Tips
• Research the tokenomics and utility of the borrowed asset to ensure the potential rewards outweigh the borrowing costs.
• Start with small amounts to test the strategy and understand the workflow before committing larger sums.
• Keep track of your loan health factor to avoid liquidation risks; keep your health factor above 1.
• Consider setting up alerts for significant price movements in either your collateral or the borrowed asset.

Debt Refinancing

Decentralized lending and borrowing protocols allow users to optimize their positions by refinancing debt — a strategy that allows users to optimize their borrowing positions by taking advantage of changing market conditions or interest rates.

Debt Refinancing

1. Monitor interest rates: Identify different asset interest rates across the lending protocol markets

2. Borrow a lower-interest asset: Use this borrowed asset to repay a higher-interest loan by swapping it for the other asset on a DEX

3. Pay less interest: Save on interest costs over time

Real-World Example | Debt Refinancing

1. Current loan of 1,000 HBAR at 5% APR

2. Borrow 100 USDC at 3% APR as a new loan — equivalent to 1,000 HBAR, assuming an HBAR price of 10¢

3. Swap USDC for HBAR by using a DEX

4. Repay HBAR loan, resulting in a 2% savings in annual interest

Advanced Strategies: LST Yield Multiplier, Leveraged Long-Short, & Arbitrage

For experienced DeFi users, decentralized lending protocols offer the potential for implementing sophisticated strategies that maximize yields and manage risk. These advanced techniques require a deep understanding of DeFi mechanics and careful management.

Liquid Staking Token (LST) Yield Multiplier

This strategy leverages the relationship between a native asset (e.g., HBAR or SAUCE) and its liquid staking derivative (e.g., HBARX or XSAUCE) to create a leveraged position that earns staking rewards.

1. Supply LST Asset: Supply a LST asset as collateral into its associated liquidity pool

2. Borrow Native Asset: Borrow the native asset against the LST asset collateral supplied

3. Swap LST asset for Native: Use a decentralized exchange to swap the LST asset for its native asset.

4. Repeat: Increase leverage by following this process recursively until holding the desired amount of the LST asset.

Real-World Example | Leveraged Liquid Staking Token Yield

1. Deposit 1,000 HBARX into its associated liquidity pool

2. Borrow 771 HBAR against the HBARX supplied — assuming a 60% loan-to-value (LTV) ratio and 1.285 exchange rate between HBAR / HBARX

3. Using a decentralized exchange, swap the 771 HBAR for 600 HBARX

4. Current position: 1,000 HBARX collateralized; 600 HBARX held in wallet; total holdings of 1600 HBARX earning 1.6x leveraged yield

5. Repeat until desired leverage is reached

Risks

• Higher liquidation risk due to leverage — ensure your health factor doesn’t drop below 1
• Dependency on the liquid staking protocol's security
• Potential divergence between HBAR & HBARX prices

Leveraged Long-Short Positions

This advanced technique involves simultaneously taking leveraged long and short positions to profit from price movements while minimizing overall market exposure.

1. Supply Collateral: Deposit a supported asset into its associated liquidity pool on your lending protocol of choice.

2. Borrow ½ in Asset A (Long): Borrow an asset you believe will rise in price relative to Asset B.

3. Borrow ½ in Asset B & Swap for Stablecoins (Short): Borrow an asset with historical price action that is inversely correlated with Asset A — immediately sell it for stablecoins using a DEX.

4. Monitor and Manage: Continuously monitor the price movements of both assets and manage your position accordingly.

5. Buy Back Asset B: If this strategy plays out as expected (Asset A rises and/or Asset B falls), buy back Asset B using the stablecoins held — this should result in acquiring more of Asset B than your original borrow position.

6. Close Position: Repay both Asset A and Asset B borrow positions. Any remaining stablecoins or additional Asset A represent your profit from the strategy.

7. Risk Management: Throughout the process, monitor your collateral ratio to avoid liquidation risk, and be prepared to adjust your position if market movements are unfavorable.

Risks

• Requires active management and market timing
• Potential for losses if both assets move unfavorably
• Increased complexity and monitoring requirements

Arbitrage with Flash Loans (Developer)

Flash loans allow you to borrow assets without collateral, as long as the loan is repaid within the same transaction. This opens up unique arbitrage opportunities:

1. Identify Asset Price Discrepancies: Look for price differences of the same asset across different exchanges or protocols.

2. Execute Flash Loan: Borrow the required amount of a stablecoin using a flash loan.

3. Buy Asset at Lower Price: Use the borrowed stablecoins to buy the target asset on the exchange offering it at a lower price.

4. Sell Asset at Higher Price: Immediately sell the acquired asset on the exchange offering it at a higher price, receiving more stablecoins than initially borrowed.

5. Repay Flash Loan: Return the originally borrowed stablecoin amount plus fees to the lending protocol.

6. Collect Profit: Keep the remaining stablecoins as profit from the arbitrage.

Real-World Example

1. HBAR Price Discrepancy Identified, whereby it's $0.10 HBAR on DEX A; $0.11 HBAR on DEX B

2. Borrow 1,000 USDC via flash loan

3. Swap 1,000 USDC on DEX A for HBAR at $0.10 price — resulting in 10,000 HBAR

4. Swap the 10,000 HBAR on DEX B at $0.11 (higher) price for USDC — resulting in 1,100 USDC

5. Repay 1,000 USDC flash loan plus the 0.9 USDC fee (0.09%)

6. Keep the remaining 99.1 USDC as profit

Risks

• Failed transactions due to price slippage or insufficient liquidity
• Smart contract risks
• Competitive market with slim margins

Risk Management & Considerations

Engaging in DeFi strategies, especially advanced ones, requires a strong understanding of the associated risks and a robust approach to managing them. Here's an overview of key risk management considerations when participating in DeFi protocols:

Responsible Use Guidelines

Decentralized finance ecosystems are dynamic and offer a wide range of innovation and possibilities for those willing to explore. It's crucial to approach any strategy and protocol with caution and responsibility — here’s a few key tips to be mindful of:

• Start Small: Begin with basic strategies and smaller amounts as you learn
• Always Be Learning: Continuously expand your knowledge of DeFi mechanics and market dynamics
• Risk Management: Always prioritize understanding and mitigating risks over chasing high yields
• Stay Informed: Keep up with the latest developments in the Hedera ecosystem and broader DeFi space
• Practice Due Diligence: Thoroughly research and understand any protocol or strategy before committing funds

Liquidation Risks

Liquidation is a critical risk in collateralized lending protocols, like Bonzo Finance. It occurs when the value of your collateral falls below a certain threshold relative to your borrowed amount.

• Health Factor: This is a numerical representation of how close your position is to liquidation. A health factor below 1 triggers liquidation.
• Loan-to-Value (LTV) ratio: This determines how much you can borrow against your collateral. Always borrow less than the maximum to create a safety buffer.
• Liquidation Threshold: The point at which your position becomes eligible for liquidation. It's typically higher than the maximum LTV.
• Liquidation Penalty: An additional fee charged if your position is liquidated, which can significantly increase losses.

Monitoring Market Conditions

Market conditions can rapidly affect the viability and profitability of your DeFi strategies. Key factors to monitor include:

• Asset price volatility: Sudden price movements can impact collateral values and borrowing capacities.
• Interest rate fluctuations: Changes in supply and demand of assets in lending & borrowing protocols can drastically affect borrowing and lending rates.
• Overall market sentiment: Bull or bear markets can influence the effectiveness of certain strategies.
• Protocol-specific metrics: TVL, utilization rates, and governance decisions can impact strategy viability.