Recursive Lending Risks

Recursive Lending Risks arise when a user deposits an asset as collateral, borrows another asset, and then uses that borrowed asset as collateral elsewhere to repeat the process. This creates a loop of leverage that amplifies both potential gains and losses.

While it increases capital efficiency, it also makes the entire system highly fragile. If the price of the collateral drops, a cascade of liquidations can occur across multiple protocols simultaneously.

This creates a systemic risk where the failure of one position leads to a chain reaction of liquidations that can destabilize the entire ecosystem. Understanding the extent of this recursion is vital for regulators and protocol designers aiming to limit systemic contagion.