Recursive Collateralization

Recursive Collateralization involves using a derivative token or a receipt token from one protocol as collateral to borrow assets in another protocol, which are then used to acquire more of the original asset. This practice artificially inflates the total value locked in a system while increasing the fragility of the entire network.

If the value of the underlying asset falls, the collateral in all linked protocols becomes insufficient, potentially triggering simultaneous liquidations across the ecosystem. It is a common strategy for yield farming but acts as a major systemic vulnerability.

The complexity of these loops makes it difficult for participants to accurately assess their true risk exposure. It creates a synthetic layer of leverage that is invisible to traditional risk models.