When utilized appropriately, leverage may be a very effective instrument. It helps to increase one's exposure to market opportunities and capitalize on minor inefficiencies to push markets closer to equilibrium. DeFi has yet to discover an effective model for spot leverage. Over-collateralized money markets are typically safe venues, but they are capital inefficient. The release of Gearbox v2 on Ethereum may change this. Gearbox presents credit accounts, which are basically smart contract-based wallets with some built-in capabilities. Gearbox offers a more efficient solution to leverage through credit accounts and its own separate money markets. This innovation is expected to solve the DeFi capital efficiency problem.<h2>What is Gearbox?</h2>Gearbox is a protocol for leverage. It is divided into two parts: passive liquidity providers that earn low-risk APY by offering single-asset liquidity, and active farmers, enterprises, or even other protocols that loan those assets to trade or farm with up to x10 leverage.Gearbox Protocol enables anybody to take DeFi-native leverage and use it across several protocols (DeFi and others) to generate leveraged yields, allowing you to construct your position as you see appropriate. You utilize Gearbox to gain leverage, which you then use to other protocols you already know and love, such as Uniswap, Curve, Convex, Lido, and so on. You can, for example, leverage trade on Uniswap, farm on Yearn, create delta-neutral strategies and so on.Gearbox government is a decentralized autonomous organization (DAO) operated by many contributors and teams. The protocol and assets are never in the possession of a single person. You can be in a DAO but not be active all the time, which is just acceptable. There are several ways to join involved and get rewarded for your time and expertise.<h2>Gearbox mechanism</h2>For example, suppose Jane has $10,000 USDC to trade. Jane believes token XYZ will rise in the short run and wishes to purchase XYZ with leverage. She transfers $10,000 USDC to her Gearbox credit account. She wishes to leverage up 5x on Gearbox using her USDC. She borrows 40k USDC from Gearbox's money market and purchases token XYZ worth 35k USDC. Because the collateral is usable, 5x leverage involves borrowing $40,000 USDC (for a total of 50k including collateral).If XYZ rises, Jane exits her trade and unwinds her leverage, repaying the Gearbox money market. If the token falls in value, Jane, like everyone may do, chooses to cut her losses, repays the loan, and leaves the room with a loss to her principal.Let us now dissect this circumstance. First and foremost, how did Jane obtain 5x spot leverage so easily? For a USDC loan using USDC collateral, Gearbox's risk framework enables a loan-to-value ratio (LTV) of up to 94.5%. An LTV of 94.5% suggests maximum leverage of 18.18x. Jane's leverage of 5x was far from that limit.&nbsp; The formula for calculating maximum leverage is [1/(1-LTV)].Jane is not at risk of sudden liquidation at 5x leverage. However, keep in mind that the price of the token XYZ she intends to acquire has an influence on this as well. Because Gearbox employs futures-style margining, you can borrow more than you deposit as collateral, but your account will be liquidated if your health factor falls below 1.The health factor is computed by multiplying the account's USD value by the LTV ratio. Given no interest is required to be paid, Jane's health factor when she starts her position is (50,000*0.945)/40,000 = 1.18. Jane's health factor falls to one when her account worth (assuming no interest is paid) is 42,329, meaning that Jane can lose up to 7,671 USDC before her position is liquidated.Returning to Aave, this type of flow is not possible. When your health factor falls below 1, the Gearbox credit accounts primitive lets liquidators access your assets. Since Aave and Compound permit you to withdraw to your own, personal address instead of a credit account-based address with unique features, you cannot borrow more than you deposit as collateral. &nbsp; Furthermore, this type of margining allows the borrower to perform their DeFi activity using their loan and posted collateral.Gearbox has restrictions on what you may do with the money you borrowed. You can't put it in a 12-hour-old farm or buy the newest meme coin. Given that you are gambling with other people's money, some risk management is essential. The Gearbox allowlist governs which protocols, tokens, and precise activities you may perform, which includes far more than simply margin-longing a token.<h2>Opening the door for new opportunities</h2>Access to efficient leverage expands DeFi's capabilities. The ability to leverage up beyond 1.5-2x transforms very simply, low-yield options into moderate-yield options with a comparable risk profile.Take, for example, Yearn's ETH vault. It presently returns around 4% per year, which is greater than the rate from lending ETH. And, while it is pretty safe, it is not without risk, particularly smart contract threats from Yearn deploying user ETH in other venues.&nbsp;&nbsp;Using Gearbox, you can set up a strategy of using ETH collateral to obtain an ETH loan and deposit the proceeds into Yearn.&nbsp; Depositing 2 ETH and borrowing 8 ETH - indicating 5x leverage because collateral is also usable - would allow a customer to receive Yearn's 4% APY on 10 ETH rather than simply 2 ETH. The user would now receive 20% APY with a principle of 2 ETH. The same levering-up technique may be applied to a variety of tactics, including stablecoin farms.Gearbox now has over 20 options on its platform that enable users to utilize leverage in various yield schemes.&nbsp;If you've utilized perpetual and futures, it can be difficult for you to understand how this represents a breakthrough. After all, this is akin to how CEXs carry out derivatives margining. However, this is the first time a composable leverage primitive has been implemented in DeFi.Getting leverage and using it in various settings is nothing new. You may do the same in over-collateralized money markets like Ave, Compound, and others. Effective margining is nothing new. You can achieve it using derivatives DEXs and CEXs. Nevertheless, the combination of these two features—composable leverage and efficient leverage—represents a brand-new innovation.<h2>The performance so far</h2>Recently, Gearbox's TVL exceeded $90M, with the majority of the money being held in liquidity pools. In addition to GEAR benefits, liquidity providers now get interest from borrowers. Up to a year will pass before the incentive program for Gearbox LPs is terminated, although the DAO has the right to shut it off early if it fails to yield any significant outcomes. However, the capital influx suggests that the liquidity mining program is working as intended.<img src="https://cdn.builder.news/news/11ed6be466830933a8e6023f659fee92.jpg" alt="gearbox tvl" title="gearbox tvl" width="600" height="285" class="lykafe0">Source: DeFi LlamaPreviously, the majority of capital in the protocol was in liquidity pools, with the ratio of credit accounts capital to liquidity pools capital hovering at 10-40%. With the release of Gearbox v2, that ratio has flipped, with credit accounts now holding more TVL than liquidity pools.Credit accounts are now available exclusively to people who are ready to borrow more than $100,000. Before they may mint credit accounts, these people must be accepted on Discord. The product will eventually be made available to the whole public.We can look at data on assets inside credit accounts to gain a sense of what current customers are doing with their credit accounts.<img src="https://cdn.builder.news/news/11ed6be4668310afa8e6023f659fee92.jpg" alt="gearbox credit account asset" title="gearbox credit account asset" width="600" height="283" class="lykafe1">Prior to v2, USDC, yvDAI, and yvUSDC collateral dominated credit accounts. It makes sense considering that leverage and depositing cash in Yearn (yvDAI and yvUSDC are both Yearn vault tokens) is a pretty secure and simple method to boost returns.However, with the release of v2, Gearbox witnessed a significant rise in demand for leverage, with TVL rising from roughly $3m to $50m in less than a week. The increase in credit account TVL may be linked in significant part to the provision of liquidity in the FRAX-3RV pool, stETH liquidity schemes, and Yearn vaults for DAI and WETH.A pertinent side notes: it's extremely possible that as Gearbox credit accounts become more widely available, yields for venues on the allowlist will begin to shrink. If the market has access to 2-4x Yearn's vault returns, it will seize the chance.Finally, Gearbox's treasury has around $5 million in the runway to allow the DAO to continue releasing features. The increases in July and September 2022 are the consequence of direct capital raises to the DAO. However, fee-based aspects play a role in helping to build the DAO's runway.<img src="https://cdn.builder.news/news/11ed6be4668315b2a8e6023f659fee92.jpg" alt="gearbox treasury" title="gearbox treasury" width="600" height="280" class="lykafe2">Source: Dune Analytics<h2>Value accrual</h2>A few fee levers are now included in Gearbox's current architecture. Firstly, when liquidations take place, the borrower is subject to a 5.5% penalty, of which 4% goes to the liquidator as compensation and 1.5% gets to the Gearbox DAO.Secondly, 50% of the spread that a borrower pays is taken by the Gearbox DAO. In essence, the borrower is paying 7.5% (5%*1.5) – 5% to lenders and 2.5% to the DAO — assuming the borrowing rate for USDC is 5%.Finally, when LPs leave a pool, they are charged a 1% fee on their notional amount. According to Gearbox's whitepaper, this is not anticipated to be in effect for very long. Therefore, it appears to be a tool to encourage LPs to continue participating in the protocol and supplying short-term liquidity.There aren't any more fees on Gearbox than these. No fees for trading, creating credit accounts, or anything else. It's a wise early move. Create a product that users will want to purchase, then start charging for it. The goal is not to start collecting every penny of fees right now but to start doing so once the protocol has reached some level of escape velocity.So, logically, there is a way to value accumulation. There are a few existing fee levers, as well as a couple more significant ones that may be implemented. However, as seen by the narrative of Uniswap and the fee switch, there may be community opposition, particularly from professional investors, to enabling token value accretion.However, Gearbox is still in its early stages in terms of product development. Talk of value accretion is a little too soon. Nonetheless, the DAO has a way to sustainable revenue.<h2>Conclusion</h2>Gearbox has the potential to transform the user experience of DeFi speculation by introducing actual leverage to spot markets and yield-bearing possibilities. The space has yet to see capital-efficient leverage provided in a permissionless manner, and a solution like this has various ramifications for the DeFi ecosystem. Demand for leverage in DeFi has dropped dramatically, as indicated by decreases in loan originations and existing loans on protocols such as Aave, Compound, and Maker. However, because Gearbox allows you to employ leverage to directly boost yields, it has the capacity to overcome market circumstances. The question is whether it will truly happen.As previously mentioned, one far-reaching impact is the compression of DeFi yields as consumers get access to more spot-market leverage. However, it is vital to remember that the ultimate yield for borrowers is their (leveraged yield – borrowing costs). As a result, this opportunity will last only until an equilibrium is found between highly leveraged yields and Gearbox borrowing rates. When the cost of yield equals the yield, demand for leverage falls.As we have discussed earlier, credit account TVL flipped liquidity pool TVL. That is why GEAR incentives on the supply side make sense for the near future. As the demand for leverage grows, so do the yields on Gearbox for liquidity providers. It is critical to maintain constant inflows in the pools in order to keep rates fair as demand scales.Furthermore, traders should use caution while engaging with protocols that provide significant leverage, such as Gearbox. While leverage may be a beneficial tool for improving capital efficiency and capitalizing on market opportunities, it can also spell disaster for many traders/farmers who lack caution and effective risk management.Altogether, Gearbox is one of the few recent outstanding projects in DeFi, and we should keep an eye on its future advancements and traction closely.<div class="pr-block-special">Disclaimer: This article is intended for and only to be used for reference purposes only. No such information provided constitutes advice or a recommendation that any investment or trading strategy is suitable for any specific name.</div>

The release of Gearbox v2 on Ethereum may change this. Gearbox presents credit accounts, which are basically smart contract-based wallets with some built-in capabilities.

Gearbox: The solution to DeFi capital efficiency problem