Looping

Looping (a very DeFi term) is a form of carry trade where there should be no inherent price risk as the loan asset being borrowed is correlated to the collateral asset.

This allows a speculator to borrow and purchase more of their collateral to multiply their exposure to the underlying collateral return. Looping typically involves very high levels of leverage as lower price risk will minimize (but not eliminate) the risk of a liquidation.

Typical strategies in DeFi involve investing in staked ETH, earning the staking rate, borrowing ETH and staking it again. The trade is profitable only if the borrow rate is lower than the staking rate.

USD-based strategies typically involve carrying a spread between the cost of borrowing in DeFi and the native return of the asset. For instance, tokenized funds with aggressive return profiles can be used for overcollateralized loans to borrow USD.

An example of a USD-based strategy is speculators looping the Fasanara mF-ONE private credit fund.

For more details: https://kitchen.steakhouse.financial/p/midas-fasanara-mf-one-in-morpho-onchain

High levels of leverage make the strategy very sensitive to changes in the underlying borrow rates. If borrow rates spike higher than the collateral rate, the position will degrade its equity.

While there is no theoretical price exposure, there can still be instances of liquidation triggered by changes in the secondary market price, if the repo market derives its price from secondary trading.

Finally, if there is an impairment in the collateral that results in a decline in principal value at the collateral level, the likelihood of a liquidation increases significantly and those losses are magnified by leverage.

An illustrative ETH-based looping vault is shown below: