4.3 Collateralization ratio

Example 2: Collateralization Ratio and Risk Management

Let's consider a leveraged yield farming scenario with a collateralization ratio (CR) requirement. Assume you have $10,000 worth of collateral (C) and can borrow up to 3x leverage. The protocol sets a minimum collateralization ratio of 150%, meaning your collateral must be at least 1.5 times the borrowed funds (L).

If the borrowed funds (L) amount to $20,000, the required collateral (R) would be calculated as follows:

Required Collateral = L / CR = $20,000 / 1.5 = $13,333.33

In this example, you would need to have at least $13,333.33 worth of collateral to meet the 150% collateralization ratio requirement and be eligible for borrowing $20,000.

These examples demonstrate how leveraged yield farming can potentially amplify returns. However, it's crucial to understand the associated risks, such as potential liquidation if the value of the collateral drops significantly or if the yield farming strategy does not perform as expected. It's recommended to thoroughly assess the risks, fees, and terms associated with leveraged yield farming before participating.