Looping: where the leverage hides inside a four percent spread

A four point spread between what a market pays suppliers and what it charges borrowers looks like a modest carry trade. Looped through the same market it becomes a leveraged position whose outcome depends on a health factor, and the leverage is invisible on any page showing the spread instead of the balance sheet.

The loop, step by step

Start with 1,000 USDC in a market with an 80% maximum loan-to-value. Supply the 1,000. Borrow 800 against it. Supply the 800. Borrow 640. Supply the 640.

After three steps the position supplies 2,440 and owes 1,440. Equity is still 1,000, because every borrowed unit went straight back into collateral. Leverage is 2.44 times. The loan-to-value on the whole position is 59%, not 80%, because only the final tranche sits at the maximum. Keep looping and the average climbs toward 80%: the series converges, so each step is smaller than the last and the position approaches the limit without reaching it.

That convergence is why “loop five times” and “loop to the maximum” are nearly the same trade. Risk per step shrinks and the risk already on the book does not.

The spread is not the yield

Carry is supply multiplied by the supply rate, minus debt multiplied by the borrow rate. Two things drive it: the spread on borrowed money, and the base rate on your own.

Run it with a stated assumption, not a market quote: supply at 8%, borrow at 4%, 2,440 supplied, 1,440 borrowed. Gross carry is 195.2 minus 57.6, or 137.6 on 1,000 of equity, about 13.8%.

Change the assumption and the intuition breaks. With supply at 5% and borrow at 1% the same loop earns 122 minus 14.4, or 10.8% on equity, for the same four point spread. With supply at 8% and borrow at 7% the carry falls to 9.4%.

Looping adds no capital, so every extra point of carry is bought with borrowed money and paid for in liquidation risk.

The health factor is the whole trade

The health factor is collateral value times the liquidation threshold, divided by debt. Above one, nothing happens. Below one, anyone may repay part of the debt and take collateral at a discount.

At 2,440 supplied, 1,440 borrowed and an 82.5% liquidation threshold, the health factor is 1.40. Collateral can fall about 28.5% before the position is callable. That reads as comfortable, and it is the number a dashboard shows you.

Two things make it the wrong number to lean on. The buffer narrows as steps are added, because the average LTV converges upward toward the maximum. And it is measured against a price, so a fall arriving in one candle does not come with 28.5% of time to react. It produces a liquidation and a bonus paid out of your collateral.

The exit you cannot take

Unwinding means repaying debt and withdrawing collateral, both in the same market, and in a crunch the market is the problem.

As utilisation approaches its ceiling the withdrawable balance shrinks, because most of the supplied asset is out on loan. A looped position that wants to deleverage needs exactly that balance, at the same moment as every other looped position.

This is where the comparison with a futures market breaks. A futures position can be closed against a book that clears at a price. A lending position can only be closed if the pool holds unused liquidity, and the pool is least liquid when the trade is most crowded (what utilisation does to lending rates).

There is a worse exit. Selling collateral to repay debt works only if the collateral is the borrowed asset. A position looped with a volatile collateral against a stablecoin borrow cannot be deleveraged in slices, because the sale moves the price the health factor depends on. Part of the exposure is operational too: a loop run from a hot wallet is one key from a total loss (how much sits in a hot wallet).

What to do next

Before the first loop, write down three numbers: the health factor at entry, the collateral fall that takes it to one, and the pool’s withdrawable liquidity at that instant. Then re-run the third assuming half the other looped positions want out at the same time.

If the position only works at full leverage, it does not work. It is a bet on the spread holding, the price holding, and the pool staying liquid.

Verdict

Looping is not a yield strategy. It is a leveraged long position in the spread between two rates, collateralised by an asset whose price you do not control, financed by a pool whose liquidity you share with everyone running the same trade.

The four point spread is the reason to look. The health factor is the reason to size. The withdrawable liquidity is the reason the exit is priced by somebody else.