Crypto News – Liquidation Risks Rise as Crypto Loans Approach Danger Zone
Crypto News – According to analytics firm IntoTheBlock, the total amount of crypto-collateralized loans within 5% of their liquidation price has reached its highest level in over two years, indicating a potential increase in market volatility and liquidation cascades ahead.
High-Risk Loans Hit Two-Year Highs
On Wednesday, the volume of these so-called high-risk loans surged to $55 million, marking the highest level since June 2022. These loans are categorized as “high-risk” because they are defined as being within 5% of their liquidation price. This situation raises significant concerns among traders regarding possible liquidations that could trigger wider market instability.
Understanding the Risks of Decentralized Lending
In the decentralized lending market, crypto traders frequently draw loans by locking in collateral in the form of digital assets. However, this practice comes with inherent risks. If the value of the collateral decreases too much, the lending protocol automatically liquidates the loan by selling off the collateral. For instance, a loan that is within 5% of the liquidation price means that if the collateral’s value drops by just 5%, it will no longer adequately cover the loan, triggering an immediate liquidation event.
The Cascade Effect of Liquidations
The surge in high-risk loans is particularly alarming because it can lead to a liquidation cascade. This self-reinforcing cycle occurs when multiple liquidations happen rapidly, causing a significant drop in crypto prices. Such a price decline can further incite additional liquidations, escalating market turbulence.
Impact on Market Dynamics
IntoTheBlock highlighted the repercussions of large-scale liquidations, stating, “Large liquidations can impact the collateral value, putting more loans at risk of liquidation, creating a downward price spiral.” Rapid market declines can lead to insufficient collateral to cover loans, resulting in poor depth and losses for lenders.
Moreover, the firm cautioned that bad debt from liquidations could adversely affect market liquidity, complicating the execution of large trades at stable prices. “Bad debt can keep lenders from adding new liquidity to prevent potential losses,” IntoTheBlock noted, emphasizing the importance of managing risk in a volatile market environment.
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