Leverage has been a tempting and dangerous game within the cryptoverse for some time now, and it seems like every day, new lending protocols are offering their services to users, encouraging them to borrow against their assets to increase their rebasing gains: the legendary (9, 9) strategy.

During the most recent BTC dip that occurred just this week, a large amount of liquidations were seen within the Olympus/OHM community. While many thought that their positions were safe, the markets moved quickly and caught a lot of users off-guard. While borrowing against your assets may at first seem like a big-brain play, it is incredibly important that you understand the risks associated with making such decisions. These risks are unique to each lending platform but can include:

  • The potential for your assets to depreciate.
  • A liquidation threshold that determines when you have defaulted on your loan.
  • Interest rates associated with your loan.

First, you must be aware of your asset value and the risk of its potential decline. Extremely volatile assets, such as a new DAO on launch day, carry far greater risk than Stable Coins. The increased volatility of an asset can cause extreme fluctuations in price which, in turn, can alter your Liquidation Ratio in the blink of an eye.

Secondly, the liquidation threshold of each platform is unique. Some offer ratios of 120%, while others may only use 110%. This is truly a golden rule that must be respected: you must keep your collateral value above water, or else, you will be drowned in a liquidation.

To explain this concept, please see the series of infographics below. These infographics are incredibly basic, and use numbers that are overly simplified. In addition, this scenario assumes that there will be 0% interest charged to you for borrowing.

As you can see, this investor has taken out a loan, and in this case, it is quite risky. Choosing to take out so much DAI might help him to gain some serious return via rebases, but if the value of his collateral drops ever so slightly, he is in real danger of being liquidated.

One of the best ways to protect yourself from liquidation is to be as conservative as possible with this ratio. Taking only 50 DAI, for example, would have increased the liquidation ratio to 200%, leaving much more room for potential depreciation of their collateral asset.

Market crashes can happen quickly, and are often manipulated to ensure maximum carnage. The more space you leave yourself for depreciation, the better your chances of survival. Better yet, maybe choose NOT to leverage your position. 😉

Notice that the collateral bar has fallen BELOW the 110% threshold. Now, the investor’s account is able to be selected for liquidation. In the liquidation process, the borrowing investor is required to pay back the entirety of the loan value, PLUS an additional percentage, determined by the lender. This payment is taken from the collateral asset. Many people do not consider the fact that during liquidation, their collateral asset is in a devalued state, meaning that they are forced to sell their asset at lower prices. Sell-low, buy-high is something we should always try to avoid, right?

Finally, we see the state of affairs post-liquidation. The leveraged assets have been used to repay the outstanding debt, and the ABI has been sold-off for the low price of $8.70. Even though they only borrowed $80.00 of DAI, they were forced to pay the extra 10% that was agreed upon when taking the loan.

In addition, immediately after the market crash and liquidation, other investors ‘bought the dip,’ and increased the price of ABI instantaneously. As a result, this investor will be forced to accept their losses, and then, potentially re-buy ABI at higher prices. In the end, the ABI holdings took a big hit, and the unfortunate investor holds only a fraction of their previous purchasing power.

Ultimately, leverage attracts investors for the instant gratification that it offers, causing us to ignore the potential risks. Free money and more gains can be incredibly tempting, however, in many cases it would be best to look for more reliable alternatives. Bonding within your DAO protocol, for example, can be an excellent way to increase your percentage gains while boosting the treasury at the same time.

Month after month, it seems there are stories all around the cryptoverse, recounting the massive liquidations that cause assets such as BTC and OHM to crash. The bottom-line is simple; each investor must make the choices that best suit their needs. While the trend of (9, 9) sings the siren-song of increased gains, it also brings substantial risk in its wake that has the potential to decimate a portfolio.

From one Abachian to all of you, be careful out there. One ABI, One Community!