The biggest liquidation event in crypto history took place on Friday, with over $19 billion worth of positions getting rekt in just 24 hours, according to CoinGlass. In the days since, industry experts have undertaken a postmortem on the chaos — and the rise in leverage has been highlighted as a potential risk to the crypto market’s long-term health.
The surge in popularity in Hyperliquid, a decentralized exchange that specializes in perpetual futures trading, has made leverage in crypto more accessible than ever before, leading to rival exchanges competing over their leverage offerings. Some experts believe this is creating systemic risk, with asset management firm Bitwise even considering a change in strategy as a result.
Leverage allows traders to make bets using borrowed funds, which creates the risk of being forcibly liquidated if things go wrong. Often, leverage is combined with perpetual futures trading, which allows traders to speculate on the direction of an asset — called going “long” or “short” — with derivatives contracts that never expire.
Explaining the Bitcoin Crash: What Are Liquidations and Leverage?
These trading strategies combined create immensely upsized risk, which is amplified and exposed by big moves like on Friday. In traditional markets, restrictions and assessments are placed on users attempting to access the highest levels of leverage.
Similar systems are in place with centralized exchanges, with Binance, for example, requiring users to pass risk quizzes to trade with any leverage at all. However, the decentralized exchange Hyperliquid has grown rapidly this year, offering leverage up to 40x with no know-your-customer disclosures or quizzes required — and that’s part of the selling point.
“What we’re seeing, especially in the perps markets, is that leverage is the point of competition with these exchanges. Margin competition is driving systematic risk, in that sense,” Aryan Sheikhalian, head of research at venture capital firm CMT Digital, told Decrypt. “They’re competing by lowering collateral ratios or cross-margining assets that are potentially correlated, or increasing liquidation thresholds too late as a result of this competition that’s underlying.”
This competition can even be seen with the recent emergence of rival decentralized exchange Aster, which offers eye-watering leverage up to 1,001x on Bitcoin.
As a result, CoinShares Head of Research James Butterfill told Decrypt that derivatives trading volume, which allows for leverage to be used, has more than doubled in size over the past year. And when compared to spot trading, he said, derivatives account for 73.7% of volume on centralized exchanges.
