Analyzing Alpaca Finance: High-Interest DeFi Savings and Leveraged Mining

Author: Xu Ming'en

This article introduces, from the perspective of beginner users, a lending platform with higher lending rates. For advanced users, it can also serve as a tool for leveraged mining.

Let's start with the simplest DeFi lending.

Lending Platform

The essence of saving is borrowing.

Users deposit money into a bank, which then lends that money out, collects interest, and finally shares a portion of that interest with the depositors. This is the source of savings interest. DeFi lending works the same way. The only difference is that DeFi lending does not have a bank serving you; instead, it is fully handled by smart contracts on the blockchain.

The key to the interest rate is the utilization rate, which reflects the changes in the supply and demand for money. The higher the utilization rate of a lending platform, the more money users have deposited that is being lent out, leading to an increase in lending rates. Conversely, if the utilization rate is low, it means that users' money is just sitting in smart contracts "gathering dust," resulting in lower lending rates.

Alpaca's high lending rates are primarily due to its ability to attract more people to borrow money.

Why do people insist on borrowing money from Alpaca? This is related to another feature on the platform—mining (farming).

Leveraged Mining

Taking Alpaca's BNB-USDT liquidity mining pool as an example, if I set the leverage to 1x, Alpaca's current annual yield is about 46%, similar to other automated financial management robots.
One-time leverage

If I participate in liquidity mining with $100 worth of BNB, Alpaca will first sell $50 worth of BNB for an equivalent amount of USDT, maintaining a 50:50 ratio between BNB and USDT. Thus, I can participate in liquidity mining with $50 worth of BNB paired with $50 worth of USDT, totaling $100.

Assuming that the price of the coin and the interest rate remain unchanged in the future, this $100 will turn into $146 worth of BNB and USDT after one year. This is the simplest form of liquidity mining.

However, Alpaca also allows advanced players to use "leveraged mining"—borrowing money to enhance the total yield from mining. The following image shows the situation when I set the leverage to 2x, increasing the mining annual yield from the original 46% to 93%.
Two-time leverage, borrowing USDT

But this does not mean that liquidity mining becomes easier to profit from. Rather, Alpaca automatically borrows money from the lending market to increase the principal invested in mining, thereby enhancing the total yield from mining. The annual yield is calculated based on the amplified total yield and the initial principal, which results in a noticeable increase in the annual yield.

For example, if I invest $100 worth of BNB into the BNB-USDT liquidity mining pool and set it to 2x leverage, it means I want to invest a total of $200 in mining. At this point, Alpaca will automatically use BNB as collateral to borrow $100 worth of USDT from the lending market. I can then invest a total of $200 in liquidity mining with my original $100 worth of BNB and the borrowed $100 worth of USDT. This is 2x leverage.

Of course, borrowing money comes at a cost. Currently, the annual interest rate for borrowing USDT is about 16%, which still attracts many people because, although borrowing is expensive, the profits made can fully cover the costs and still yield a profit.

In the previous two examples, while 1x leverage incurs no borrowing interest, the annual yield is "only" 46%. In contrast, while 2x leverage incurs relatively high interest, the annual yield increases to 93%. Seeing a more profitable option, people are naturally eager to borrow money for mining.

This is also the main reason why Alpaca's lending rates are higher; it drives up the utilization rate through leveraged mining, which ultimately reflects in the lending rates. However, conversely, if one day the mining yield is not as high, or even lower than the borrowing cost, leveraged mining may turn into a losing business.

If 2x leverage is not stimulating enough, Alpaca allows for a maximum of 3x leverage.

Using the same example of investing $100 worth of BNB into the BNB-USDT mining pool, if set to 3x leverage, it means the user wants to invest a total of $300 in mining, which is $150 worth of BNB and $150 worth of USDT. Alpaca will use BNB as collateral to borrow an additional $200 worth of USDT, and will convert $50 of that into BNB.

This results in a total of $300 invested in mining. If the price of BNB remains unchanged or increases, a higher total yield can be earned, thus increasing the annual yield.
Three-time leverage, borrowing USDT

The higher the leverage, the greater the risk.

With collateral comes liquidation. If the price of BNB drops, causing the collateralized BNB to be insufficient to repay the borrowed BNB and USDT assets, it will be liquidated by Alpaca. In the worst-case scenario, you may only recover 10% of the assets you initially invested.

The higher the leverage ratio is set, the worse the ability to withstand market fluctuations, and the higher the probability of being "liquidated." Therefore, cryptocurrency investors often remind each other: "Cherish life, stay away from leverage."

I do not recommend beginners use leveraged mining. However, if you are a professional player, you will certainly discover the hidden "short mining" feature behind Alpaca.

Short Mining

Pure liquidity mining requires holding spot assets to provide liquidity and earn transaction fees, generally only allowing for long mining. Short mining allows professional players to continue mining while shorting. This is considered a very advanced operation.

This time, I will invest $100 worth of USDT into the BNB-USDT mining pool and set it to 3x leverage. This means I want to invest a total of $300 in mining, which is $150 worth of BNB and $150 worth of USDT. The difference this time is that I will let Alpaca use USDT as collateral to borrow $200 worth of BNB and first sell $50 worth of BNB for USDT. This still totals $300.
Three-time leverage, borrowing BNB

Since BNB was sold first, this creates a shorting effect. If the price of BNB drops in the future, it can be bought back at a lower price to repay. However, during this period, the investor still enjoys the mining profits, which is the essence of short mining. The downside is that if the price of BNB rises, it means that not only will the borrowing interest need to be paid, but more money will also be needed to buy back BNB for repayment. It becomes a losing proposition.

Some may say that short mining is suitable for bear markets, but I have a different opinion. The main sources of income from liquidity mining are transaction fees and platform token rewards, but in past bear markets, it was not just the price of coins that fell; trading volumes also dropped significantly. This results in liquidity mining's transaction fee income being far below current levels, and it may not even cover the interest on the borrowed funds. In other words, while short mining may be suitable for times when coin prices are falling, it may not be suitable for use in bear markets where trading volumes are also struggling.

In summary, I would categorize Alpaca into two usage modes: beginner version and advanced version.

Using only the lending market is the beginner version. By entrusting funds to Alpaca's smart contracts, the utilization rate is maximized, allowing you to earn the most interest. As long as the smart contracts have no vulnerabilities and Alpaca's liquidation mechanism operates normally, users can enjoy higher lending returns. In addition to lending interest, they can also stake the lending certificates in Alpaca or Autofarm to earn additional platform rewards.

The advanced version involves using leveraged mining. By borrowing more assets from the lending market, different results can be achieved based on the borrowed assets, leading to long or short mining outcomes.

Combining lending, leverage, and mining is a very interesting innovation to enhance lending rates. However, this is not unique to Alpaca; currently, on Ethereum, especially on Solfarm, there are some liquidity mining pools with originally high annual yields that become even more astonishingly high after leveraging.

As long as you understand the sea, the sea will help you. But the problem is that the sea is too difficult to understand.