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Risks
Although we take a multitude of safety precautions and Alpaca is audited, farming and participating in DeFi comes with certain risks. Below, we discuss the potential risks associated with using Alpaca Finance.
- Risk:⚠
- If you try to open a large position relative to the pool size and require swapping, you transaction could incur a large price impact.
- As an example, if a liquidity of a pool is USD 100 million, swapping USD 1 million (1% of pool’s liquidity) worth of tokens would incur ~4% price impact.
- If you are unfamiliar with how price impact works for AMM, please read here on how xy = k AMMs work.
- Mitigation:ℹ
- Open multiple smaller positions or open a smaller position and add collateral to that position at a later time. You should wait for a short interval for arbitrageur to bring price back to normal.
- Bring a combination of asset that require lower swapping requirement-e.g., if you want to open a 2x leverage on CAKE-BNB pair. Supplying only CAKE token will result in a very small swap amount because the Vault will loan to you approximately equal value in BUSD.
- Avoid opening and exiting position in a short period of time.
- When exiting a large position, choose "Minimize Trading" strategy to reduce price impact from swapping asset and trading fees
- Risk:⚠
- Risk of (impermanent) capital loss from asset rebalancing in the Automated Market Maker ("AMM") pool.
- Even stablecoin pairs can be subject to impermanent loss if the price of at least one moves off peg. While in general, the IL from this is small and transient, historically, there have been instances where stablecoins have stayed off-peg for extended periods of time. By opening a position with large leverage, you are also amplifying the potential IL on your principal.
- Mitigation:ℹ
- Impermanent loss is not unique to Alpaca Finance. It is common among all yield farming and AMMs. While we currently do not yet have a way to mitigate IL, users can choose to yield farm asset pairs that have high correlations to minimize potential IL. For more information on IL, you can start with this article.
- Risk:⚠
- This is a scenario where the borrowing interest rate is higher than your yield farming gain. This means your debt position will grow faster than your equity value. If this continues for a period of time, it could reduce your equity value down to the level that triggers liquidation.
- Likely causes for this scenario to occur are 1.) high borrowing pool utilization, pushing up the borrowing interest rate. 2.) A significant price drop in the rewards token - i.e., CAKE causing the farming yield to drop.
- Mitigation:ℹ
- Monitor your positions closely and have a plan if APY turns negative - i.e., close position, wait and see, or add collateral to the position.
- If utilization remains high for a period longer than a few days, the team will analyze the situation and likely raise the borrowing interest rate which should lower utilization.
- Exercise cautions when opening a position if the pool's utilization is high.
- Risk:⚠
- If you open a leveraged yield farming position, Alpaca Finance borrows a base asset for you to farm. You run the risk of being liquidated if price of the borrowed asset appreciates against the farming token pair. Your position will be liquidated when the Debt Ratio (debt / position value) reaches the Liquidation Debt Ratio aka Kill Threshold. See Pool-Specific Parameters for more information.
- Mitigation:ℹ
- This can be mitigated by using a lower leverage level, monitoring positions during volatile market conditions, and closing them before hitting the liquidation parameters.
- Risk:⚠
- While our smart contracts have been audited by third-party firms, they could theoretically have vulnerabilities. Integrated 3rd-party platforms like the AMMs we build on can also carry smart contract risk.
- Mitigation:ℹ
- Having smart contracts audited by multiple professional third-party firms decreases the chance of vulnerabilities. You can find audit reports here.
- We also run a bug bounty program to provide incentives for people to look for vulnerabilities in our live code as an extra layer to filter out any potential issues. More on that here.
- We carefully screen any platforms we integrate with, only working with those that have been audited and shown a track record of good security.
While we do our best to eliminate all the possible risks, DeFi is an industry where events that no one predicted can occur(the dreaded black swans). So please don’t invest your life savings, or risk assets you can’t afford to lose. Try to be as careful with your funds as we are with our code. 😊