Module 9: DeFi Deep Dive
Leverage and Looping in DeFi
Chapter 11 of 14 · about 5 minutes
11.1 The loop
Mint saw a strategy described online: "Deposit staked ETH, borrow ETH against it, stake that ETH, deposit it again, and repeat. Turn a 3% staking yield into 4%, 6%, or more."
"That sounds too easy," said Mint.
"It's called looping," said Hash. "It's one of the most popular strategies in DeFi, and it works, until the conditions it depends on change. Let's see exactly what you're borrowing, and what could break."
11.2 Leverage in DeFi
In DeFi, leverage is created by borrowing against collateral and using the borrowed funds to increase exposure. Unlike perps (Module 7), where leverage is built into the contract, DeFi leverage is assembled step by step from lending protocols and swaps.
11.3 Leveraged long ETH
This is a separate illustration from Node's home-repair loan in Chapter 5, not the same position. Here Node wants more ETH exposure, so Node deposits 10 ETH at $3,000 ($30,000), borrows $15,000 USDC, buys 5 more ETH, and deposits it as additional collateral.
| Value | |
|---|---|
| ETH collateral | 15 ETH = $45,000 |
| Debt | $15,000 USDC |
| Node's equity | $30,000 |
| Exposure | 15 ETH, or 1.5x leverage |
| Health factor (82.5% threshold) | 2.48 |
| Liquidation price | ~$1,212 |
| ETH moves | Without leverage (10 ETH) | With 1.5x leverage (15 ETH, $15,000 debt) |
|---|---|---|
| +30% | +$9,000 (+30%) | +$13,500 (+45%) |
| −30% | −$9,000 (−30%) | −$13,500 (−45%) |
Leverage amplifies results in both directions, plus Node pays interest on the $15,000 debt. More loops would mean more exposure, a higher liquidation price, and a smaller margin of safety (Chapter 6).
11.4 LST looping
The strategy Mint saw uses liquid staking tokens (Chapter 8).
- Deposit an LST as collateral.
- Borrow ETH against it.
- Swap or stake that ETH into more LST.
- Deposit the new LST as collateral.
- Repeat until reaching the target leverage.
Because both the collateral (LST) and the debt (ETH) are priced in ETH terms, ETH's dollar price matters much less. The strategy earns the difference between the LST staking yield and the ETH borrow rate, multiplied by leverage. Many lending protocols offer efficiency modes with higher LTVs for correlated assets, allowing more loops.
Example at 3x leverage, with equity of 10 ETH worth of LST:
| Value | |
|---|---|
| LST collateral | 30 ETH worth |
| ETH debt | 20 ETH |
| LST staking yield | 3% |
| ETH borrow rate | 2.5% |
| Yield on collateral | 30 × 3% = 0.9 ETH |
| Interest on debt | 20 × 2.5% = 0.5 ETH |
| Net yield on 10 ETH equity | 0.4 ETH = 4% |
The loop turns a 3% staking yield into 4%. That's the appeal.
11.5 What can go wrong
Borrow rates rise. The strategy only works while the borrow rate is below the staking yield.
| ETH borrow rate | Net yield on equity at 3x |
|---|---|
| 2.5% | 4% |
| 3.0% | 3% |
| 4.0% | 1% |
| 5.0% | −1% |
When many people loop at once, ETH borrowing demand rises, pushing up utilisation and borrow rates (Chapter 5). Above the rate model's kink, borrow rates can spike, turning the strategy negative quickly.
The LST depegs. If the LST's price falls relative to ETH, the collateral loses value while the ETH debt doesn't. With an illustrative 93% liquidation threshold in an efficiency mode:
Liquidation occurs when LST price ÷ ETH price falls to about 20 ÷ (30 × 0.93) ≈ 0.717
A 28% depeg sounds extreme. But higher leverage, achieved through more loops, pushes the liquidation point much closer. Many protocols also price LSTs using their redemption rate rather than market price, partly to avoid liquidations from temporary DEX discounts. That reduces one risk while introducing reliance on the oracle design (Module 3, Chapter 12).
Chapter 11 · How each loop thins the buffer
Starting from 10 ETH of LST with no debt, each loop borrows ETH worth 80% of the last deposit, stakes it, and deposits it again, with a 93% liquidation threshold. Loop 1: 18 ETH collateral, 8 ETH debt, 1.8x exposure, health factor 2.09, liquidated if LST/ETH falls to 0.48. Loop 2: 24.4 ETH collateral, 14.4 ETH debt, 2.4x, health factor 1.58, liquidation at 0.63. Loop 3: about 30 ETH collateral and 20 ETH debt, about 3x, health factor about 1.40, liquidation at 0.717. Looping on approaches 50 ETH collateral and 40 ETH debt, 5x, health factor about 1.16, liquidation at 0.86.
Liquidity to unwind. Closing a loop requires repaying ETH debt, which means selling LST for ETH. If many loopers unwind at once, LST liquidity can thin, worsening prices and discounts.
Slashing or protocol failure. A problem at the LST protocol hits a position that's leveraged several times over.
11.6 Building and unwinding loops
Doing many loops manually costs gas and swap fees each time. Many users rely on:
| Tool | How it helps | Added risk |
|---|---|---|
| Flash loans (Module 3, Chapter 12) | Build or unwind the full leverage in one transaction | Contract complexity |
| Automated vaults | Manage leverage and rebalancing | Vault contract and strategy risk |
| Protocol "one-click" leverage | Convenient interface | Hidden assumptions; read what you sign (Module 2, Chapter 7) |
11.7 Stablecoin loops
Similar loops exist with stablecoins: depositing a yield-bearing stablecoin, borrowing a regular stablecoin against it, converting, and redepositing. The same logic applies: the strategy earns the spread between the collateral's yield and the borrow rate, amplified by leverage, and is vulnerable to rate changes and depegs between the two stablecoins (Chapter 7).
11.8 Node's view
"So looping is a bet that the spread stays positive, the peg holds, and you can always get out," said Node.
"Exactly three bets at once," said Hash. "When all three hold, it's steady extra yield. When one breaks, leverage makes it hurt."
11.9 Try it yourself
Find the current staking yield for a major LST and the ETH borrow rate on a large lending protocol. Calculate the net yield of a loop at 2x, 3x, and 5x leverage. Then calculate the borrow rate at which each becomes unprofitable. Finally, find the LST's lowest price against ETH over the past two years and compare it with the liquidation ratio for each leverage level, using the method in section 11.5.
Key takeaways from this chapter
- DeFi leverage is built by borrowing against collateral and using the funds to increase exposure.
- Leveraged long positions amplify gains and losses and move the liquidation price closer.
- LST looping earns the spread between staking yield and borrow rate, multiplied by leverage.
- Loops turn unprofitable if borrow rates rise above the staking yield, which can happen quickly when many loop at once.
- LST depegs, unwinding liquidity, and protocol failures are amplified by leverage.
- Flash loans and vaults simplify looping but add contract complexity.
- Every loop is a bet on the spread, the peg, and the ability to exit.