Leveraged Liquidity

What is leveraged liquidity

Leveraged liquidity means providing liquidity (minting nTokens) and then borrowing against that liquidity in the same currency to provide more liquidity. Notional allows you to use nTokens as collateral for your debt which enables you to use a lot of leverage.

Leveraged liquidity allows you to get leveraged exposure to the nToken yield in a given currency. Users can create leveraged liquidity positions by borrowing at the variable rate or at a fixed rate.

Who is leveraged liquidity for

Leveraged liquidity is for advanced DeFi users who want to get the maximum returns out of their capital.

Leveraged liquidity can also be a good option for users who want to increase their NOTE incentive yield.

Where does the yield come from

Leveraged liquidity positions earn yield from their liquidity. Liquidity providers earn yield from interest accrual, transaction fees, and NOTE incentives.

The total return of a leveraged liquidity position depends on the liquidity yield and the rate that a user is paying on their debt. If the liquidity yield is higher than the borrow rate, leveraged liquidity positions can produce large returns.

What are the risks

Leveraged liquidity providers have five main risks:

  1. 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.

  2. 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.

  3. Negative return risk. The total return on your leveraged liquidity position can change as the liquidity yield changes or as the variable borrow rate changes if you have borrowed at a variable rate. Changing rates could lead to a negative total return for your position.

  4. Price risk. Leveraged liquidity providers are long nTokens. This means they have nToken price risk. nToken price risk means they can lose money if the nToken price decreases.

  5. Liquidation risk. Not all leveraged liquidity providers 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 nToken price declines could lead you to get liquidated.

Transaction fees

Entering a leveraged liquidity position involves transaction cost if you are borrowing fixed, but it does not involve transaction cost if you are borrowing variable. This is because there is no cost to mint nTokens and no cost to borrow variable, but there is a cost to borrow fixed.

Exiting a leveraged liquidity position always involves transaction cost. There is a cost to redeem nTokens and there will also be a cost to exit a fixed rate borrow. There is no cost to pay off a variable rate borrow.

What happens when your debt matures

If you have chosen a fixed rate for your borrowing, your fixed rate will automatically convert to the variable borrow rate at maturity. There's no penalty for this, your leveraged liquidity position will stay open, and there's no action necessary from you.