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Understanding Risk When Using Leverage

‘Swapping’ mechanisms are inherent to the DeFi ecosystem at large and provide a basis to all decentralised financial activity – whether this be simply trading between a token pair, buying or selling tokens, staking, or even farming tokens. As the ecosystem has developed, more TradFi swapping mechanisms have begun to adapt for DeFi, with leveraged swaps at the forefront of the gradual transition to DeFi.

The Current Standard For Leverage Swaps

Drawing upon the existing leverage swap technology in the TradFi world, DeFi leverage swaps allow customers to orchestrate a trade agreement with an issuer whereby they collateralize their existing assets in order to borrow against their current position and ‘leverage’ this as a safety net. In doing so, customers then owe the issuer and can invest in other financial products or assets and subsequently earn a yield on both positions, all while the collateralized assets act as a risk defence on the behalf of the issuer. 

Yet, the amount that can be borrowed by a customer is entirely dependent on the volume of assets they are willing to collateralize. Say a protocol offers up to 5x leverage on any position, this will starkly differ between a customer willing to deposit $50 in collateral versus another depositing $500. 

If a customer’s portfolio teeters into dangerous levels of risk, the issuer will often liquidate the customer’s position, with the customer then being obligated to repay the amount borrowed. Risk in the context of leveraged positions typically denotes financial products that vary in volatility or long or short-term projected performance. For example, a very volatile financial product that has a short-term investment sentiment would be classed as a higher risk product in comparison to a minimally volatile, long-term product. However, if the portfolio avoids this territory, customers will still have to repay their loan obligation with an interest rate charged as standard. 

Currently, leverage swaps are a complex process within DeFi that require several intermediaries to successfully execute leveraged swaps. As of now, a majority of DeFi users looking towards leveraged swaps as an option for their portfolio are required to deposit their collateral into a lending protocol, reap the proceeds and migrate them to a swapping protocol, all before withdrawing the final proceeds and depositing them back into the lending protocol.

Unsurprisingly, this results in an array of complications for DeFi users embarking on this lengthy process. Whether it be a lack of liquidity transparency, a complex repayment system, short repayment terms, or even extortionately high-interest rates – this process has become one that is certainly not for the faint-hearted. The tedious and inaccessible nature of DeFi leverage swaps has called for a solution – which has now been developed by Jet Protocol.

How Jet Flips The Script

Built upon Solana, Jet’s leverage swap leverages the composability inherent to DeFi by interconnecting their margin accounts with margin pools and trading venues courtesy of Orca. By streamlining the aforementioned process, Jet users are able to perform leverage swaps within the protocol itself, as well as through Orca using their external wallet, for both long and short-term positions without the hassle of a multi-step process. Allowing users to access up to 10x leverage on crypto pairs (depending on the asset composition) and up to 20x on stablecoin pairs, DeFi leverage swaps have been reimagined into an accessible and linear process.

Jet Protocol’s leverage swapping mechanism enables users to seamlessly collateralize approved tokens and borrow against the former to obtain a range of approved SPL tokens. Harnessing an automated system, any tokens received from these trades are automatically deposited into Jet’s margin pool, where they are then able to accrue a yield. 

Say for example a user had $100 in BTC in their margin account and wanted to invest in SOL, all while maintaining their current position in the former. The user could easily collateralize their BTC and swap in a SOL/USDC pool, buying SOL with USDC, without actually holding USDC. Through the collaboration between the protocol and its on-chain programme, USDC will automatically be borrowed against the collateralized BTC to allow the user to purchase SOL in the swap pool. In essence, the user collateralizing their BTC is the catalyst for automatic borrowing and margin swap execution mechanisms. This opens up possibilities for users to easily set up large leverage positions with a single instruction in a single transaction.

Maintaining a similar liquidation process to the former, users are fortunately no longer left in the dark about the risk of their positions. Boasting an innovative and transparent risk index, any Jet margin account holder can easily view the risk rating of their positions, granting them greater control over when they withdraw and repay their loan obligations – as opposed to a covert liquidation on the behalf of the issuer. 

Unlike other leverage swapping mechanisms, the interoperability of both margin accounts and margin pools enables users to isolate their risk into separate sub-margin accounts. Gone are the days when users would have to bundle various leveraged positions into one account and potentially jeopardise their collateral – instead, users can now create a multitude of accounts reserved for specific assets, risk factors, and trading strategies. This means that if one position is liquidated the user’s entire portfolio won’t suffer the repercussions of this, instead protecting their collateral and their other leveraged positions.

Unlike a majority of DeFi and TradFi protocols that maintain specific interest rates that only seem to be raised, Jet Protocol’s interest rates on users’ loan obligations fluctuate based on market conditions and liquidity. Additionally, with no specific repayment date, users can gradually repay their loan obligations through automatically withdrawn payments courtesy of their margin account or external wallet, or they can manually repay the loan in its entirety using either method. 

With transparency at its core, Jet Protocol also enables users to easily view the liquidity of the protocol at any given time through the landing page of their margin account. Paired with a multitude of other visual widgets, users can easily access a plethora of information relating to the protocol and their margin accounts, and can even reshuffle this interface to suit their specific preferences.

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