High-risk cryptocurrency loans are rising again, and according to insights from analysts, the growth cannot be considered a positive occurrence for the digital asset space.
Data from the market analytics platform IntoTheBlock shows that high-risk loans have surged to the $5 million region, a level last seen during the crash of many crypto lenders in May/June 2022.
High-risk Loans Spike to May 2022 Level
High-risk loans are often used to take advantage of arbitrage opportunities in the crypto market. They consist of various activities, including ones where traders buy crypto assets for lower prices in one market and instantly sell for higher prices in another, all in one transaction. While these loans can enable participants to make quick money, they are usually accompanied by risks due to the volatility of crypto assets.
One major issue with high-risk loans is the possibility of traders losing their collateral when the assets' prices fall below the liquidation level.
IntoTheBlock says high-risk loans are those within 5% of liquidation; the assets posted as collateral are very close to their liquidation prices. Analysts insist that the growth of high-risk loans is a significant indicator to monitor in crypto lending protocols because they can contribute to market liquidity issues.
Potential Market Liquidity Issues
According to IntoTheBlock, rapid market plunges can cause the collateral needed to cover loans to become insufficient, leading to bad debt and losses to lenders. Large liquidations from insufficient collateral can trigger a downward price spiral of cryptocurrencies, putting more loans at risk and causing even more declines.
Additionally, cascading liquidations can prevent crypto lenders from adding new liquidity to their markets to mitigate potential losses.
The last time high-risk loans spiked to their current level, roughly a dozen crypto firms, particularly lending platforms, went up in smoke. Entities like Celsius Network, Voyager Digital, Three Arrows Capital, BlockFi, and Babel Finance became insolvent.
The numerous implosions could be attributed to several factors, including the volatility of cryptocurrencies, which triggered the depegging of the algorithmic stablecoin terraUST and its sister coin, LUNA.
The collapse of the TerraLUNA ecosystem had a domino effect that caused a massive liquidation of loans due to insufficient collateral. As IntoTheBlock explained, the massive liquidation caused even more liquidity issues that worsened the crypto winter.