Crypto Markets Show Signs of Strain as Leverage Grows

Crypto markets are seeing a big increase in leverage, reaching levels last seen during the bull market. This surge is driven by a strong demand for decentralized finance (DeFi) lending and a higher appetite for risk. However, this rapid growth in leverage is causing some stress points in the market. Last week, Bitcoin's price dropped from $124, 000 to $118, 000, which led to over $1 billion in liquidations across crypto derivatives. This was the largest wipeout of long positions since early August. Analysts view this as a healthy correction rather than a reversal, but it highlights how quickly things can change when leverage builds up fast. Galaxy Research's Q2 report shows that crypto-collateralized loans grew by 27% last quarter, reaching $53. 1 billion. This is the highest level since early 2022. The report also points out that in July, a wave of withdrawals on Aave pushed Ethereum borrowing rates above Ethereum's staking yields. This broke the economics of the popular "looping" trade, where staked ETH is used as collateral to borrow more ETH. The unwinding of this trade caused a rush to exit staking positions, sending Ethereum's Beacon Chain exit queue to a record 13 days. Additionally, borrowing costs for USDC in the over-the-counter market have been climbing since July, while on-chain lending rates remain flat. This spread between the two has widened to its highest level since late 2024. This disconnect suggests that demand for dollars off-chain is outpacing liquidity on-chain, which could amplify volatility if conditions tighten further. Despite these stress points, strategists remain optimistic about crypto due to strong institutional demand and ETF inflows. However, with ballooning loan volumes, concentration of lending power, DeFi liquidity crunches, and a widening gap between on-chain and off-chain dollar markets, the system is showing more signs of strain.