Recursive Leverage Risk

Recursive leverage risk occurs when users deposit assets into a lending protocol, borrow against them, and then re-deposit the borrowed assets to borrow even more. This creates a chain of leverage that multiplies both the potential returns and the potential risks of the initial position.

While this strategy is popular for maximizing yield, it makes the user's position extremely sensitive to even minor price movements in the underlying assets. If the price of the collateral drops, the entire chain of positions can quickly become under-collateralized, triggering a cascade of liquidations that forces the user to sell all their positions at once.

Because these positions are often automated, they can be liquidated without the user's manual intervention, leading to rapid, total loss of capital. This behavior amplifies systemic risk, as many users engaging in recursive leverage simultaneously can create significant sell pressure during market downturns.