Looping is a process of repeatedly supplying and borrowing the same asset on a lending platform that rewards both lenders and borrowers with its own token. By doing this, the traders can increase their yield and earn more tokens than they would by just holding the asset. However, looping also exposes them to various risks, such as liquidation, impermanent loss, and smart contract bugs.
Here is a simplified example of how looping works:
- Alice deposits 100 ETH on a platform that pays 10% interest in ETH and 5% interest in its own token, LOOP: She can earn 10 ETH and 5 LOOP from interest.
- Alice borrows 80 ETH using her deposit as collateral. She pays 8% interest in ETH and 3% interest in LOOP: Now she has 180 ETH in deposit which earns 18 ETH and 9 LOOP Meanwhile she needs to pay 6.4 ETH and 3.2 LOOP in interest.
- Alice borrows 80 ETH again, pays 8% interest in ETH and 3% interest in LOOP: She needs to pay 6.4 ETH and 3.2 LOOP for this borrowing. Together with previous borrowed ETH, she needs to pay 12.8 ETH and 6.4 LOOP for interest in total. But she has 260 ETH in deposit and she can earn 26 ETH and 13 LOOP from interest.
- Her profit so far: 13.2 ETH (26–12.8) and 6.6 LOOP (13–6.4)
- Alice repeats this process until she reaches the maximum borrowing limit of the platform, which is usually…
