Looping Solana LSDs: DeFi Degen 101

BbyA...nMtW

14 Apr 2023

Looping in Decentralised Finance

The looping strategy in DeFi is a process of supplying an asset and borrowing against that same asset continuously to earn a higher yield. This is because some DeFi platforms reward users for both lending and borrowing with their native tokens or other incentives.
By looping, users can increase their exposure to these rewards and earn a positive net APY.

However, looping also involves risks such as liquidation, impermanent loss, and smart contract failures. To use the looping strategy in DeFi, users need to find a platform that supports it, and follow the steps to deposit, borrow, and redeposit the same asset until they reach their desired leverage level.

Looping with Solana LSDs

I think looping works best with those LSD (liquid staking derivatives) tokens that have staking rewards compounded into the LSD token itself.

The rewards are lower but the risk is also lower because:

You're borrowing and lending in the same token so impermeant loss is unlikely.
- Not completely though. Whilst LSDs are a 1 for 1 exchange for the base token (plus staking rewards) they are still a separate token issued by a protocol and NOT the blockchain token they represent ownership of. Should a protocol get hacked, suffer fraud, or simply be really poorly run you risk losing your funds.
Staking rewards are reliable. If you balance your funds correctly your positions will gradually pay themselves off over time.

$SOL is one of these tokens whose staking program works this way.

How to Loop with liquid staked SOL

To start with you want to deposit your collateral in the liquid staked token ($stSOL, $mSOL, $daoSOL etc..) because that collateral will grow over time thus increasing your liquidation threshold, essentially helping you pay off the loan.

When you borrow you want to borrow in either the base token (in this case $SOL) or, if that isn't possible/efficient, the staked version IF the borrow rates on the base token are unworkable i.e., higher than the staking rewards.

The reason you probably don't want to borrow in another token (like a stablecoin) is you risk slippage in your loan.

Should your collateral be in $stSOL and your loan be in $USDC and the price of $stSOL falls, then your liquidation threshold will narrow, as you now have less collateral to your loan.

If the price of your base token rises the opposite effect happens, and you see more upside, but it's much more risky.

Another important factor to consider is the deposit + staked vs borrow rates. In the case here (at time of writing) you get a slightly higher rate on your deposited staked tokens than it costs you to borrow them.

Risk Management

Factor in the staking rewards and you are relatively safe levering up in like for like position which will pay itself off over time. However that doesn’t mean it’s set and forget.

You’ll need to monitor the interest rate spread and the staking rewards as you can see your loans liquidate if deposit + staking returns go down and borrow goes up.
This is amplified if you’ve borrowed in a different asset (yet another reason to avoid that).

Some notes on particular Solana lenders:

Hubble will only lend to you in $USDH, a stablecoin, but they don’t charge any interest. They just require you to maintain a liquidity threshold below 80% which does impact how much leverage you can take out.
Larix offers like for like deposits and lending and you can arbitrage across different assets to achieve a large positive gain (at time of writing deposit $mSOL for 12.94% and borrow $USDT at 2.60%).

In both cases you’ll need to monitor your positions over time as they carry the extra risk of slippage I explained above.

I'm of the opinion that you should be looking for sustainable long term yields in cryptocurrency and leave the silly "to the moon!" stuff for gamblers (cause that's what it is).

A safer strategy will still see you achieve healthy returns even if the price of the token remains the same or even falls a little.

If the price increases then that's a great bonus, but you don't need price volatility in order to see returns.
Think 2 years, not 2 weeks.

How DeFi thrives, not just survives

If you engaged in this industry because you honestly believe in it's ability to reshape finance into a fairer system (as I do) then you know that that will only happen with average returns of ~10% and will never ever happen with returns of ~1000%.

Volatility is poison to any serious financial products. No one wants to gamble with their core finances so the more ****coins, and crypto bros, we can chase out of this space the faster we can clean up it's reputation.