Crypto Markets Show Signs of Strain as Leverage Grows

Leverage Reaches Bull Market Levels

Crypto markets are experiencing a significant increase in leverage, mirroring levels last seen during the bull market. This surge is driven by strong demand for decentralized finance (DeFi) lending and a higher appetite for risk. However, this rapid growth is causing notable stress points in the market.

Bitcoin Liquidations Highlight Market Volatility

Last week, Bitcoin's price dropped from $124,000 to $118,000, leading 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 underscores how quickly conditions can shift when leverage builds up rapidly.

Crypto-Collateralized Loans Hit Record Highs

Galaxy Research's Q2 report reveals that crypto-collateralized loans grew by 27% last quarter, reaching $53.1 billion—the highest level since early 2022. The report also highlights that in July, a wave of withdrawals on Aave pushed Ethereum borrowing rates above Ethereum's staking yields. This disrupted 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.

Widening Gap Between On-Chain and Off-Chain Dollar Markets

Borrowing costs for USDC in the over-the-counter (OTC) 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.

Strategists Remain Optimistic Despite Market Strain

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 increasing signs of strain.