Leveraged lending means borrowing at one rate in a currency (like USDC) and lending at a different rate in that same currency. Notional allows you to use the loan as collateral for the debt which enables you to use a lot of leverage.
Leveraged lending allows you to arbitrage Notional's interest rates within a single currency by borrowing at a low rate and lending at a higher rate. Using leverage allows you to amplify your returns.
Leveraged lenders can borrow at the variable rate and lend at a fixed rate or borrow at a fixed rate and lend at the variable rate.
Who is leveraged lending for
Leveraged lending is for advanced DeFi users who want to get the maximum returns out of their capital.
Additionally, it is recommended that leveraged lenders are familiar with the concepts of fCash and fCash trading. The best way to understand the risks of leveraged lending is to understand how fCash and fCash trading work.
Where does the yield come from
Leveraged lending yield comes from lending to borrowers on Notional. The yield that leveraged lenders earn depends on the difference between their borrow rate and their lend rate.
If their lend rate is higher than their borrow rate, high leverage means that they can earn large returns.
What are the risks
Leveraged lenders have five main risks:
Smart contract risk. A hack of Notional’s smart contracts or the smart contracts of any protocol where Notional holds funds could result in loss.
Bad debt risk. All borrowing on Notional is over-collateralized. If the value of a borrower's collateral falls and liquidators don’t purchase the collateral quickly enough, Notional could be left with bad debt.
Negative return risk. As Notional's variable rates change, the total return on your leveraged lending position will change. Changing variable rates could make your borrow rate greater than your lend rate which would make the total return of your position negative.
Price risk. Leveraged lenders are always either long fCash if they're lending fixed or short fCash if they're borrowing fixed. This means they have price risk for the fCash maturity they chose. Price risk means they can lose money if the fCash price moves in the wrong direction.
Liquidation risk. Not all leveraged lenders have liquidation risk. Liquidation risk can be avoided by using limited amounts of leverage. But if you use a lot of leverage, it's possible that fCash price changes could lead you to get liquidated.
When you trade fCash, you pay a fee. The current fee is 0.3% on the APY. This means that your fee is smaller when fCash is closer to maturity and larger when maturity is farther away.
The more leverage you take, the more fCash you will need to trade on entry and exit. This means that higher leverage positions involve more transaction cost than lower leverage positions.
You can exit by waiting until your fCash position matures, but you don't have to. You can also deleverage by trading out of your fCash position before maturity at the current market price for your fCash.
What happens at maturity
When your fCash matures, whether it is a loan or a debt, it will automatically net off against your variable rate position. This will leave you with your initial capital + any profit or loss you made on your leveraged lending position.