Introduction

When used correctly, leverage can be a powerful tool. It helps amplify one’s exposure to market opportunities and take advantage of small inefficiencies to bring markets closer to equilibrium. DeFi is yet to see an efficient model for spot leverage. Over-collateralized money markets are relatively safe venues, but the one thing they lack is capital efficiency.

The launch of Gearbox v2 on Ethereum could potentially change this. Gearbox introduces a new primitive, called credit accounts, which are essentially smart contract-based wallets with certain built-in features. Between credit accounts and its own independent money markets, Gearbox brings a more efficient approach to leverage.

How Gearbox Works

For example, let’s say Alice has 10k USDC she wants to trade with. Alice thinks token XYZ stands to appreciate in the short-term, and she wants to buy XYZ with some leverage. She deposits that 10k USDC into her Gearbox credit account. She wants to use her USDC to lever up 5x on Gearbox. She borrows 40k USDC from Gearbox’s money market and buys 35k USDC worth of token XYZ. Note that since the collateral is usable, 5x leverage entails borrowing 40k USDC (for a total of 50k including collateral).

If XYZ goes up, Alice closes her trade and unwinds her leverage — thus paying back the Gearbox money market. If the token goes down a bit, Alice decides to cut her losses like a responsible degen, pays the back loan, and walks away with a loss to her principal.

Now, let’s unpack this scenario. First off, how did Alice get 5x spot leverage so easily? Gearbox’s risk framework allows for a loan-to-value ratio (LTV) up to 94.5% for a USDC loan using USDC collateral. A 94.5% LTV im