High-Risk Crypto Loans Soar to Highest Level in 2 Years, What Does This Mean?

High-risk cryptocurrency loans are on the rise again, and according to analysts’ insights, the growth cannot be considered a positive event for the digital asset space.

Data from market analysis platform IntoTheBlock shows that high-risk loans have surged into the $5 million region, a level last seen during the collapse of many crypto lenders in May/June 2022.

High-Risk Loans Soar to May 2022 Levels

High-risk loans are often used to take advantage of arbitrage opportunities in the crypto market. They consist of a variety of activities, including those in which a trader buys a crypto asset at a lower price in one market and immediately sells it at a higher price in another market, all in one transaction. While these loans allow participants to make money quickly, they usually come with risks due to the volatility of crypto assets.

One of the main problems with high-risk loans is the possibility of traders losing their collateral when the asset price falls below the liquidation level.

IntoTheBlock says high-risk loans are those that are within 5% of liquidation; the asset used as collateral is very close to its liquidation price. Analysts insist that the growth of high-risk loans is an important indicator to monitor in crypto lending protocols as it can contribute to market liquidity problems.

Potential Market Liquidity Problems

According to IntoTheBlock, a rapid market downturn could cause the collateral needed to cover loans to be insufficient, leading to credit crunch and losses for lenders. Massive liquidations due to insufficient collateral could trigger a decline in cryptocurrency prices, putting more loans at risk and causing more downturns.

Additionally, tiered liquidations can prevent crypto lenders from adding new liquidity to their markets to reduce potential losses.

The last time high-risk lending surged to current levels, about a dozen crypto companies, primarily lending platforms, went bankrupt. Entities such as Celsius Network, Voyager Digital, Three Arrows Capital, BlockFi, and Babel Finance went bankrupt.

This multiple boom could be attributed to several factors, including cryptocurrency volatility, which triggered the depegging of the algorithmic stablecoin terraUST and its sister coin, LUNA.

The collapse of the TerraLUNA ecosystem created a domino effect that led to massive loan liquidations due to insufficient collateral. As IntoTheBlock explains, massive liquidations led to more liquidity issues that exacerbated the crypto winter.