Farm Vaults allow users to leverage yield farm vault locations using rover credit accounts.
First, each deposit into a farm vault creates a single-line credit account. Fig. 14 shows at a high level how deposits work with the OSMO ATOM strategy, resulting in an effective 2x leverage ratio for the user.
A leveraged yield farming position in the Fields of Mars
This allows the user to farm with leverage with increased yield (in the form of OSMO tokens given out as retention rewards). However, should the value of OSMO fall, the risk of liquidation increases. Both scenarios are shown below.
In scenario 1 (Fig. 15), the user supplies ATOM and borrows OSMO from the Red Bank’s OSMO pool. ATOM and OSMO are deposited in the ATOM-OSMO LP pool and included in the osmosis staking contract. As long as the return on fees and OSMO rewards exceeds the interest rate, the user’s profit will grow faster than the cost of borrowing.
The value of the LP asset remains constant or increases
In Scenario 2 (see Fig. 16), the ATOM-OSMO LP share is held as collateral by the smart contract and the value of the collateral and debt is tracked over time (using the AMM itself as the oracle). When the debt to collateral ratio exceeds a certain level defined in the smart contract (i.e. the margin requirement), the LP portion is liquidated to repay the debt.
The value of the LP assets decreases, leading to liquidation
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