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Over-Leveraging in Compound v3

While borrowing can amplify your returns, over-leveraging can quickly lead to liquidation if markets turn against you. Over-leveraging occurs when you borrow too close to your maximum allowed limit or use borrowed funds to mint more collateral in a recursive loop.

What Is Over-Leveraging?​

  • Definition: Taking on more debt relative to your collateral than is prudent, often by repeatedly borrowing and swapping into new collateral deposits.
  • Risk Amplification: Each cycle of borrowing and redepositing magnifies both potential gains and potential losses.

Example: Recursive Borrowing Loop​

  1. Initial Supply:
    • Supply 1 ETH at $2,000; CF = 75% → max borrowable = $1,500.
  2. First Borrow:
    • Borrow $1,000 USDC (≃67% of max → somewhat safe).
  3. Swap & Redeploy:
    • Swap $1,000 USDC for 0.5 ETH (at $2,000/ETH).
    • Deposit additional 0.5 ETH as collateral.
  4. Second Borrow:
    • New collateral = 1.5 ETH ($3,000), max borrowable = $2,250.
    • Borrow another $1,200 USDC.
  5. Cycle Continues:
    • Each iteration increases debt and collateral but reduces your safety buffer.
    • Even a small price drop can push you past the liquidation threshold.

Why It’s Dangerous​

  • No Cushion: Borrowing near your CF leaves little room for price swings.
  • Interest Costs: Accrued interest increases your debt over time.
  • Rapid Liquidation: A sudden price drop of 10–20% can trigger liquidation across all leveraged layers, causing fire-sale penalties.

How to Avoid Over-Leveraging​

  1. Set Internal Limits: Never exceed 60% of your CF as a personal cap.
  2. Avoid Recursive Loops: Unless you’re an expert, do not borrow and redeposit repeatedly.
  3. Monitor Borrow Rates: High pool utilization increases interest rates, raising your HF risk.
  4. Plan Exits: Keep some unborrowed collateral or stablecoins handy to unwind positions quickly.

Next Steps​

After mastering over-leveraging risks, proceed to Module 1.3: Borrow Limits & Self-Liquidation to learn proactive techniques for avoiding forced liquidations.