High-Risk Cryptocurrency Loans Rise Again, Signalling Potential Market Liquidity Issues
High-risk loans in the cryptocurrency sector have surged to levels not seen since the market crash in May and June 2022, according to data from market analytics platform IntoTheBlock. High-risk loans, which are those within 5% of liquidation, are often used to exploit arbitrage opportunities in the market, but can also lead to significant risks due to the volatility of digital assets.
When the assets posted as collateral fall below the liquidation level, traders can lose their collateral, leading to market liquidity issues. Furthermore, rapid market declines can result in insufficient collateral, triggering bad debt and losses for lenders. Cascading liquidations can prevent lenders from adding new liquidity to mitigate potential losses, exacerbating the problem.
The last time high-risk loans surged to their current level, many crypto firms, particularly lending platforms, went insolvent. Factors contributing to the collapse included the volatility of cryptocurrencies and the depegging of algorithmic stablecoin terraUST and its sister coin, LUNA. This domino effect led to massive liquidation of loans due to insufficient collateral, worsening the crypto winter.
The growth of high-risk loans is considered a significant indicator to monitor in crypto lending protocols due to its potential impact on market liquidity. As such, market participants should be cautious and monitor the situation closely.
