Risks & Trade‑Offs with Looped Positions

The New Yield‑seeking Meta

As markets start to heat up again, it's clear that some things are very different from previous cycles. The old game where retail threw themselves at the latest token (or worse, a memecoin) seems to be fading and being replaced by a new game. Seasoned DeFi users have largely moved on from airdrop hunting, instead choosing to earn a steady yield on their stablecoins and other hard assets. Even some of the latest trends such as RWAs point in the same direction: using DeFi to put those assets to work in ways that were not possible in traditional finance.

A core tool here is looping. By using leverage, looping strategies are able to multiply APYs to levels that might seem absurd. However, managing a looped position comes with risks and trade‑offs that are important to understand before you start. This guide will explore what those risks are, and explain how to make decisions adapted specifically to your risk appetite.

What is Looping in DeFi?

Looping is a self‑reinforcing process. You deposit a collateral asset, borrow against it, convert the borrowed amount into more of the same collateral, and deposit again. Repeat until you reach the leverage you want. Your supply position grows with each turn of the loop, so the headline APY improves. However, keep in mind that with each loop your debt grows too, shrinking the margin for error and increasing the risk of liquidation.

Done manually, looping can be tedious. You have to hop between markets, approvals, borrows, swaps, and re‑deposits, each step carrying gas costs and slippage. Later you need to monitor your liquidation threshold, watch borrow rates, and keep one eye on the oracle that feeds the risk engine. When markets move fast, unwinding in the correct reverse order is just as involved as building the position. It can be effective, but it’s also a lot to manage.

Fortunately, platforms like Odyssey handle this for you. In Odyssey you pick the assets and a target leverage or safety buffer, then open Health to see your current liquidation price and net APY. Instead of making you execute every borrow, swap, and re‑deposit, the app uses flash loans to construct an equivalent looped exposure in one go. You review the numbers, confirm once, and the position is created on‑chain. The same flow applies when you rebalance or unwind. This doesn’t remove core risks like price moves or borrow rate spikes, but it makes building and maintaining a loop much simpler.

How to Choose the Right Leverage in Looping

At its core, leverage is a trade between yield and resilience. A handy mental model is:

Net rate (rough) ≈ (Leverage × Base yield) − ((Leverage − 1) × Borrow rate) − fees

When you choose your leverage, the main constraint is usually liquidation distance. Pick a drawdown you want to survive, and set leverage so the liquidation price sits comfortably beyond it. Use the formula only as a sanity check: when the base rate is above the borrow rate, each +1× of leverage adds roughly (base rate − borrow rate) to your net rate. If the borrow rate is higher than the base rate, don’t open the position (the net rate would be negative). For most users, these rates are effectively fixed at entry. That means that unless you're moving enough volume to significantly affect borrow rates, liquidation risk should be your main concern.

The practical process is simple: study how your chosen collateral behaves during sharp moves, decide what kind of drawdown you’re willing to ride out, and then adjust leverage until the Health panel’s liquidation price sits beyond that line. If the additional leverage barely increases your net rate or makes the buffer uncomfortably thin, you’ve gone too far.

After you open the position, keep in mind that borrow rates are usually variable. When utilization spikes, rates can move quickly, and because debt scales with leverage, the effect on your net yield is magnified. A loop that looks excellent today can turn mediocre (or negative) if borrowing costs jump. That's why it's important to frequently check borrow rates and the net yield of the position.

What can liquidate you?

In general terms, you can consider that you’re safe while (collateral value × collateral factor) is greater than (debt value). However, there are many factors that can influence those values and cause a liquidation. Here are the most important ones:

• Collateral price falls. A fast wick or a short drawdown can erase your buffer if you’re close to the line. This is the most important risk to consider, and the key scenario to base your leverage decision on.

• Borrowed asset rises. If your borrow isn’t a true 1:1 to the collateral, a move up in the borrow asset increases the value of your debt and pushes you toward liquidation. This is known as basis risk.

• Interest accrual. Borrow interest adds to your debt over time. If the borrow rate rises, the drift toward higher LTV (loan to value) accelerates.

• Oracle behavior. Liquidations use the oracle price, not the DEX chart on your screen. A brief spike in the oracle can trip liquidations even if spot snaps back; a lagging feed can delay liquidation until the next update. If a feed goes stale or is paused, protocols may freeze borrows or switch to a backup source.

• Execution and liquidity. Slippage when adjusting a position, or a failed/partial transaction, can leave you with a higher LTV than planned. Shallow books make it worse during volatility.

• Protocol changes. Collateral factors and listings can change. It’s rare, but a downgrade reduces your allowed debt against the same collateral.

Note on Odyssey. Some Odyssey options use msAssets within Metronome Synth, which are internally hard-coded at 1:1 value. For these assets, a borrow‑side depeg cannot trigger a liquidation; the key risk remains collateral price. The rest of the considerations above still apply.

Execution, Slippage, and Peg Dynamics

Opening or closing a looped position requires on‑chain swaps and loans. If you don’t watch slippage and the borrow asset’s peg, you can lose a big part of the position value, even if you do everything else right. Here's what to watch out for:

• Slippage and depth. Thin liquidity or market impact can move the fill away from your quote. You can end up with a higher LTV than planned when opening, or give back yield when closing. Check order‑book/AMM depth for the size you intend to trade; if size is material, consider splitting the order or using more controlled execution.

• Peg checks (very important). If the borrowed asset targets a peg (USD, ETH, a wrapper, etc.), opening far from that peg introduces P&L that’s separate from collateral moves. Example: if you borrow a USD‑pegged asset trading at 0.95 and later repay when it trades at 1.00, you effectively lose ~5% on the borrowed notional. The reverse can work in your favor: if possible, try to borrow at or above peg and aim to repay below peg when you unwind or deleverage the position.

Even when a protocol values some assets 1:1 for collateral purposes, your swaps still clear at market prices, so peg deviations affect entry and exit economics. In short: check the peg before you open; check it again before you unwind.

Monitoring and maintenance

Looped positions are not typically set and forget. After you open, watch LTV/health and the liquidation price and recheck after large moves so your buffer matches the drawdown you planned for. Track the borrow rate; if it drifts toward your pain point, consider closing the position unless you’re sure the borrow rate will come down soon (for example, a temporary utilization spike on Morpho). For soft or variable pegs, watch the spread between the collateral and the borrowed asset, a premium on the borrow side raises debt value. Avoid unwinding into thin books or during gas spikes and keep a small buffer of collateral or stablecoins so you can top up or repay fast.

Bottom line

Looping can make yield-bearing assets much more productive. The work is in adjusting leverage to how your collateral actually moves. Keep a clear distance to liquidation, monitor borrow‑rate changes, and check peg and slippage at entry and exit. Apps like Odyssey can simplify the mechanics, but they don’t change the risks. Get the basics right and capture long-term yield without letting a thin buffer decide the outcome.