Leveraged Liquidity
Overview
Leveraged liquidity is an advanced yield strategy to provide liquidity to Notional's fixed rate liquidity pools using leverage sourced from Notional.
This product gives you leveraged exposure to the yield from providing fixed rate liquidity - the interest, fixed rate trading fees, and NOTE incentives.
Leveraged liquidity has IL risk, negative APY risk, and liquidity risk. It's best for users that want to earn NOTE and hold the position for the medium-term.
Creating a position
To create a leveraged liquidity position, follow these steps:
Go to the leveraged liquidity page.
Pick a network.
Pick the token you want to use.
Input the deposit amount and select your borrow terms. Borrow term options show you the total APY that you will earn and the borrow APY that you will pay on your leverage.
Select your leverage using the leverage slider.
Click Continue to Review.
Click Submit.
Selecting borrow terms
Depositing to a leveraged liquidity position involves borrowing from Notional's lending markets. You can borrow at a variable rate or at a fixed rate.
Variable borrow
Zero fee on entry or exit.
Borrow rate can be volatile.
Good choice if you are short-term or if you think fixed borrow rates are too high.
Fixed borrow
Upfront fee on entry and exit before maturity. (More info on fixed rate fees here).
Borrow rate is fixed.
Good choice if you are longer-term or think the fixed rate is low.
At maturity, your fixed rate auto-converts to a variable rate and your position remains open.
Selecting leverage
Selecting your leverage changes how much you borrow which changes the borrow rate and the total APY.
The more leverage you use, the more you borrow. Usually, this means that your total APY goes up. But it can also make your total APY go down if you borrow so much that it spikes your borrow rate.
Understanding Total APY
Total APY depends on three things:
The APY on providing liquidity.
The APY spread. (APY spread = liquidity APY - borrow APY)
The leverage ratio.
You can find the calculation on the left-hand side of the page.
Organic APY vs. NOTE APY
Total APY = Organic APY + NOTE APY
The organic APY is the APY before NOTE incentives. If it is negative, it means that you will lose money if you ignore NOTE incentives. The NOTE APY is how much of your Total APY comes from NOTE incentives.
Viewing your position
To find your position, go to the holdings tab on the portfolio page.
This page will give you detailed information regarding your position, including:
Your current APY
How much you deposited
The current value of your position
Your current earnings
Default vs. Detailed view
The Notional UI gives you two options for how to view your position. You can switch between the views using the toggle in the upper right-hand corner of the portfolio holdings module.
Default view:
The Default view shows your position as one line item and gives you a good overview:
Detailed view:
The Detailed view shows your position in two parts - the liquidity asset and the debt:
The detailed view allows you to see exactly what you hold and give you a breakdown of your earnings and asset value by each part of your overall position.
Liquidation price
The Notional UI will show you a health factor and a liquidation price for your position.
Managing your position
To manage your position, switch to the default portfolio view and expand the position row. Then click the manage button.
The manage button gives you a few options:
Deposit more
Adjust leverage
Withdraw
Switch borrow terms
Depositing more
To deposit more, click the button that says Deposit.
This will take you to a transaction page with a deposit input field.
Your borrow terms and leverage ratio will be kept the same as you deposit more.
Adjusting leverage
Adjusting leverage allows you to increase or decrease your leverage without depositing more tokens or withdrawing from Notional.
Click the adjust leverage button and move the slider to your desired leverage. You can see the impact on your position on the UI:
Switching borrow terms
Switching your borrow terms lets you swap your leverage in one click while keeping your position open.
Users might want to do this if a different borrow term gives them a higher total APY. For example, if the variable borrow rate spikes, a user might want to switch from the variable borrow rate to a lower fixed rate in order to protect their total APY.
On the manage position menu, you will see one button for each borrow maturity. You will see the Total APY that you would get if you switched your borrow to that maturity.
To switch your borrow terms, just click the button and submit the transaction on the next screen.
Fees
Leveraged liquidity has two kinds of fees - liquidity fees and borrow fees.
Liquidity fees
When you deposit into a leveraged liquidity strategy, you are providing liquidity. This means that you will see a liquidity mint fee on entry and liquidity redemption fee on exit. Read more about liquidity fees here.
The Notional UI will show you a detailed breakdown of the liquidity fees on the trade summary when you enter or exit your position.
Borrow fees
Leveraged liquidity strategies include borrowing, which can include fees. Variable borrowing does not include an upfront fee, but fixed rate borrowing does. Read more about fixed rate borrow fees here.
The Notional UI will show you a detailed breakdown of the borrow fees on the trade summary when you enter or exit your position.
Liquidation risk
Leveraged liquidity includes liquidation risk. Remember - you're borrowing from Notional and using the borrowed funds to provide fixed rate liquidity. That means, you're getting leveraged long Notional's fixed rate liquidity tokens (we call these nTokens).
Liquidation can occur if the price of nTokens drops. To find out why the price of nTokens changes, skip ahead to the IL Risk section.
You can see the historical price of nTokens on the transaction page along with your liquidation price:
As you can see, nToken prices are not very volatile, so this user is not likely to get liquidated because their liquidation price is far below the current nToken price.
IL risk
Providing liquidity can lead to impermanent loss as fixed interest rates move. When fixed interest rates go up, nToken prices go down. When fixed interest rates go down, nToken prices go up.
For users who are providing liquidity without leverage, IL risk is small. But when you use leverage, IL risk can be significant.
For example, USDC fixed rates were highly volatile between March and April on Arbitrum, but the nUSDC price never fell by more than 1%:
If you were unleveraged, the worst loss you would have gotten was about 0.75%. But if you were 5x leveraged, that would have been a 3.75% loss on your capital.
But this goes both ways. If you provide liquidity just before fixed rates go down and the nToken price spikes up, you can make extra money by using leverage.
Negative APY risk
It's possible for leveraged liquidity positions to have a negative Total APY if the borrow rate increases above the liquidity yield.
In practice this is rare, but if it happens, it is usually because of two reasons:
The user has borrowed at a variable rate for their leverage
A liquidity crunch drives variable borrow rates temporarily very high due to high utilization
In this situation, the variable borrow rate is temporarily higher than the liquidity yield which causes a negative total APY.
To protect against this, users can use the fixed rate borrowing option to lock in their leverage cost.
Liquidity risk
Providing liquidity can temporarily become unredeemable due to high utilization on Notional's fixed rate markets. In these scenarios, redemption fees are either very high or it can become impossible to redeem liquidity at all.
This can be very risky for leveraged liquidity users because of negative APY risk. If nTokens are illiquid at the same time as leveraged liquidity users have a negative APY, they can be temporarily stuck in a loss-making position.
The best way to protect against this risk is to use a fixed borrow rate instead of a variable borrow rate.
nToken illiquidity cause
nToken illiquidity is caused by high utilization on Notional's fixed rate markets. High utilization on Notional's fixed rate markets is caused by high demand to borrow at fixed rates.
When this kind of demand occurs and fixed rate markets become highly utilized, the APY of providing liquidity and lending fixed becomes very high. High APYs help to attract additional liquidity and fixed rate lenders. This brings utilization down and makes liquidity redeemable again.
Fixed vs Variable Borrow
When you borrow in leveraged liquidity, there are two types of borrowing:
Fixed Rate Borrowing: This locks in a borrowing rate for the duration of the loan, so you know exactly how much interest you will pay by the time the loan matures. However, if you want to repay the loan early, the current market rate for fixed-rate borrowing comes into play. The amount you will owe may fluctuate based on whether the rate has gone up or down since you first borrowed. This can lead to profit or loss if you exit early.
Variable Rate Borrowing: With a variable rate, your interest rate can change block by block, meaning the amount of interest you owe is continuously adjusted based on the market rate. There’s no upfront fee for liquidity providers as the rate is always moving.
Borrow Interest Accrual on Fixed Rate Loans
When you take out a fixed-rate loan, you pay interest on that loan at the agreed-upon rate (e.g., 9.34% per year). The "fixed" part means that no matter what happens to the market rates after you lock in your loan, your interest rate won't change. However, if you want to close your position early, the present fixed rate in the market will impact the amount you owe.
For example:
Let’s say you borrow 100 ETH at a fixed rate of 5% for one year. If you hold the loan to maturity, you’ll owe exactly 5 ETH in interest. However, if you want to exit early, say after six months, the current fixed rate affects your payoff:
If rates stay at 5%: You have held your loan for half the time and will need to pay half the interest upon exit, or 2.5 ETH.
If rates rise to 8%: Your debt becomes cheaper. It might cost you only 2.4 ETH to repay instead of 2.5 ETH, meaning you save on interest by exiting early.
If rates fall to 3%: Your debt becomes more expensive. It could now cost 2.6 ETH to repay, meaning you’ll pay more to close the position early.
That’s why Notional shows you changes in the value of your debt even though you’ve locked in a fixed rate — it affects early repayments.
Why Does Present Value Fluctuate with Fixed Rates?
The "Present Value" of your position can change because of:
Borrow Interest Accrual: As time passes, the interest on your loan adds up, affecting your position’s value.
Market Rate Movements: Even though your fixed-rate loan is locked in, market rates fluctuate. If you were to close your position before maturity, the value of your debt might be higher or lower depending on where the current fixed rate stands compared to your locked-in rate.
Withdrawal Value Discrepancies for Fixed Rate Positions
If you notice a difference between your "Present Value" and the amount displayed on the withdrawal screen, it’s likely due to slippage caused by low fixed rate liquidity. If you have a large debt repayment, the fixed rate can move significantly, resulting in slippage loss.
You can estimate the slippage loss using this formula:
Slippage Loss = Debt Repayment Amount × Slippage Percent × Year Fraction
Example: If repaying 253 ETH causes a 3.6% slippage over 3 months, slippage loss is approximately 2.27 ETH. (253 * 0.036 * 0.25)
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