have you ever found yourself wondering why
crypto markets swing so violently so violent well more often than not the hidden ingredient is
leverage so when we saw that Galaxy Research had dropped a report that dives deep into this murky
sector of the market we knew we had to cover it so in today’s video we’re breaking down Galaxy’s
key insights to show you exactly how leverage shapes the crypto market highlighting the hidden
risks it creates and explaining why it’s something you need to watch very closely even if you
don’t trade crypto my name is Guy and this is a video you can’t afford to miss so the report
we’ll be summarizing today is titled The State of Crypto Leverage Q1 2025 it was published in
June by Galaxy Research and we’ll leave a link to the full report below if you’re interested
now before we dive any deeper let’s quickly define what leverage actually means so simply put
leverage involves borrowing money or assets to increase your allocation to the market and amplify
both your potential profits and potential losses and leverage is nothing new traders have been
using borrowed money to speculate in traditional markets like stocks commodities and forex for
decades however crypto’s high volatility makes leverage uniquely explosive causing those
sudden and violent price swings we’ve all become accustomed to now when it comes to crypto
specifically investors typically access leverage in two ways collateralized lending and leverage
trading via futures or perpetual contracts when investors use collateralized lending they
deposit crypto as collateral borrow stable coins or other assets against it and use those
borrowed funds to buy more crypto increasing their positions if the collateral’s value drops
sharply then the lender can liquidate i.e sell that collateral to ensure repayment of the loan
however the biggest liquidations typically happen with futures or perpetual contracts where traders
directly bet on crypto prices without owning the underlying assets in these instances when leverage
traders get liquidated meaning their positions are automatically closed once their margin falls below
a required threshold markets can quickly plunge or pump this kind of forced selling amplified the
crashes we saw in 2022 following the collapses of Terra Celsius BlockFi and eventually FTX turning
severe downturns into outright meltdowns and of course crypto lenders like Celsius and BlockFi
were collateralized lenders but just remember leverage cuts both ways during bull markets
traders who short crypto with leverage can get caught in so-called short squeezes forcing
them to buy back positions as prices unexpectedly spike sending markets even higher and by the way
if you’re enjoying the video so far then be sure so now that we’re all up to speed with what
leverage is and how it works we can dive into Galaxy’s report so the first section looks at
cryptocolateralized lending one of the primary ways investors access leverage at its peak back
in Q4 of 2021 this market was huge totaling nearly $65 billion in outstanding loans spread
across centralized finance or CFI decentralized finance or DeFi and cryptocolateralized stable
coins today the market currently stands at around $39 billion on the centralized finance side
lending services function similarly to traditional banks except the loans are typically secured by
cryptocurrencies instead of cash or real estate in Q1 2025 Galaxy tracked roughly $13.5 billion of
open borrows on CFI platforms representing solid growth of about 9% quarter over quarter to put
it into perspective that $13.5 billion figure is more than double the low point of roughly $6.7
billion recorded following the collapse of FTX however one particularly concerning aspect
of CFI lending is just how concentrated it is the Galaxy report reveals that Tether alone
holds a whopping 65% of the CFI lending market following behind are Leen and Two Prime which
together with Tether account for nearly 80% of all CFI crypto loans now what makes this worrying
is the lack of transparency among CFI lenders they rarely disclose detailed data about their loan
books or exactly who they’re lending to making it difficult to properly understand the risks
involved this problem was clearly illustrated when lending giants like Celsius and BlockFi
collapsed dragging the entire market down with them due to their opaque lending practices and
reckless risk management now to be clear we’re not suggesting today’s top CFI lenders are equally
fragile but such heavy concentration in just a few hands well it’s rarely a good thing it could prove
particularly dangerous once the next bare market inevitably rolls around now by contrast defy
lending platforms like Ave and Compound offer complete transparency every transaction loan and
collateral deposit is publicly viewable on chain at the end of Q1 2025 DeFi lending accounted
for around $17.7 billion in outstanding borrows which represented a quarterly decline of more
than 21% compared to Q4 of 2024 this marked the first substantial quarterly drop since late 2022
driven largely by stagnant market conditions and declining demand the remaining share around $7.9
billion is held in cryptocolateralized stable coins such as maker Dows die but here’s where
things get interesting from late March through to May the DeFi lending market has rebounded now
a big factor behind this was the introduction of Pendle tokens onto Ave if you’re unfamiliar with
Pendle you can check out our full Pendle review linked to in the description below but the TLDDR
is this pendle splits yieldbearing assets into two separate tokens one representing the principle
and another representing the yield itself these tokens proved highly attractive as collateral
because they offered loantoval ratios as high as 90% meaning borrowers could take out loans
worth up to 90% of their collateral’s value the result over $1.4 billion worth of Pendle tokens
flowed into Ave alone significantly boosting DeFi lending activity across the board but all of
this could be dwarfed if exchanges like Coinbase allow their users to borrow against their ADA
Doge and XRP directly in DeFi which as it turns out is already happening this would potentially
unlock tens of billions in cryptonative liquidity pushing the level of leverage in the crypto
markets to heights we’ve never seen before and likely pulling crypto prices up along with it
and if you want to take full advantage of this Ethereum arguably the three most important assets
in crypto lending markets let’s start with stable coins the report notes that stable coin borrowing
rates have dropped substantially over the last few months falling from an average of around
12% in January to roughly 5% by late May this marks a 57% decline which is pretty significant as
stable coins have become the lifeblood of crypto liquidity being used for everything from trading
to yield farming but what caused this massive drop in borrowing costs well Galaxy points out two main
reasons declining overall borrowing demand and a slowdown in onchain activity simply put fewer
people were borrowing crypto so interest rates on lending crypto fell in accordance with the
decline in demand interestingly enough off-chain or over-the-counter borrowing costs for stable
coins also fell during this period moving almost in lock step with onchain rates historically OTC
rates have carried a significant premium compared to onchain rates often substantially higher
but recently this gap has narrowed considerably currently USDC and USDT OTC borrow rates sit only
around 2 to 4% above their onchain equivalents much closer than in previous market cycles this
narrowing gap suggests institutional and CFI lenders are increasingly aligning their rates with
DeFi markets then we have Bitcoin lending which shows a very interesting dynamic onchain Bitcoin
borrowing mainly done using wrapped Bitcoin or WBTC has stayed relatively low and stable
that’s because in DeFi WBTC is primarily used as collateral traders deposit their WBTC then borrow
stable coins or other assets against it they don’t usually borrow WBTC itself to actively trade or
bet against Bitcoin’s price by contrast off-chain borrowing rates for Bitcoin itself remain
consistently higher this difference is mainly because OTC markets have unique demands traders
frequently borrow BTC offchain specifically to short Bitcoin or use BTC as collateral to get
loans in cash or stable coins this extra borrowing demand is why off-chain Bitcoin lending costs tend
to be much higher than their onchain counterparts and finally there’s Ethereum lending according
to Galaxy’s data borrowing rates for ETH are consistently higher than rates for staked Ethereum
or ST ETH that’s because in practice traders and investors primarily borrow ETH to engage in
leverage trading essentially borrowers take ETH loans swap the borrowed ETH into ST to
earn staking rewards and then use that ST as collateral to borrow even more as a result the
cost to borrow ETH typically stays very close to Ethereum staking yield which effectively sets a
minimum borrowing rate meanwhile borrowing costs for ST itself remain lower since users mostly hold
it as collateral rather than actively borrowing it galaxy also notes that off-chain Ethereum
borrowing costs are notably higher than their onchain equivalents institutional investors
often borrow ETH offchain specifically to short Ethereum or to use it as collateral for cash
loans additionally Ethereum’s staking yield serves as a benchmark for off-chain lending meaning
institutions are reluctant to lend their ETH below that yield further driving up borrowing costs
in OTC markets now moving on another important form of leverage highlighted by the Galaxy report
is debt issuance by Bitcoin and crypto treasury companies you’re probably familiar with names like
Micro Strategy or Strategy as they’re now called who famously started issuing debt specifically to
buy Bitcoin but they’re no longer alone dozens of companies have started following Strategy’s lead
loading up their treasuries with Bitcoin either by issuing debt or through other funding means and
if you want to know which other publicly traded companies have been stacking BTC then check
out our dedicated video on it right over here so then how exactly does this leverage strategy
work well essentially these companies issue debt typically in the form of convertible notes to
raise money from investors they then use that borrowed money to buy large amounts of Bitcoin
or even other cryptos like ETH Soul and XRP galaxy’s report notes that as of late May
2025 Bitcoin Treasury companies collectively held a staggering 122.7 billion of outstanding
debt with strategy alone accounting for nearly 65% of that figure now borrowing money to buy
Bitcoin might sound clever especially during a bull market but borrowing typically creates clear
obligations companies usually need to pay regular interest on their debt and eventually repay the
principal at maturity that said some companies like Strategy have managed to issue debt at
extremely low or even 0% interest rates which likely explains why Strategy owes only around
$17.5 million per quarter in interest payments compared to Strategy’s overall market cap of over
$100 billion that figure isn’t particularly large however there’s still a catch according to Galaxy
a big chunk of this debt matures between 2027 and 2028 exactly when the crypto market could be
deep into bare territory this timing creates two major hidden risks first if Bitcoin’s
price is significantly lower when this debt matures these companies might be forced to sell
huge amounts of BTC to repay their obligations driving crypto prices down even further second
since much of this debt is convertible investors can swap their debt for company shares if
stock prices rise above a certain level this can help companies avoid repaying debt in
cash but it also poses a risk of heavily diluting existing shareholders if prices rise or leaving
the companies burdened with massive debts if their stock prices fall so even though many of these
companies insist they’ll never sell their crypto holdings reality might eventually force them
to do so unless these companies have large cash reserves which most don’t or their stock price
stays high enough to issue new shares without hurting existing investors they might be forced to
sell their crypto this raises significant concerns about the sustainability of these treasury
strategies as more companies pile into this leveraged approach the risk of forced selling
during the next downturn increases substantially but more on that in a bit okay okay the Galaxy
report then moves on to crypto futures which is one of the largest sources of crypto leverage at
the beginning of 2025 the crypto futures market saw a significant drop in trading activity and
investor participation reflected in the declining open interest open interest by the way refers
to the total number of futures contracts that traders currently hold open representing how much
money is actively at stake in the futures market however starting around early April confidence
began returning to the market and by late May open interest had rebounded sharply nearly doubling
from roughly $68 billion to $116 billion this surge was primarily fueled by Bitcoin futures
which alone added about $23 billion to the market ethereum futures saw impressive growth as well
with open interest increasing by about 86% while Salana futures also surged gaining around 85%
but beyond just numbers the futures market has grown both amongst centralized and decentralized
platforms with each group favoring distinctly different approaches on one hand institutional
investors are gravitating towards regulated exchanges like the Chicago Merkantile Exchange
or CME as of May the CME now accounts for roughly 25% of the total crypto futures market up from
around 21% earlier this year even more notably the CME share of Ethereum futures has gone
from under 18% last November to nearly 40% now this signals that institutional investors are
growing ever more confident playing around with crypto derivatives albeit while still doing so
on centralized platforms at the same time there’s also been a remarkable explosion of interest in
perpetual futures or per primarily among retail traders unlike traditional futures contracts PERS
don’t have expiry dates allowing traders to hold leverage positions indefinitely as long as they
can maintain margin requirements that is by late May PES alone represented over 72% of the total
futures open interest reaching about $84 billion now what’s especially interesting here is the
shift happening with per platforms themselves binance historically the undisputed king of
Pers trading has seen its dominance decline instead Hyperlid has entered the arena gaining
ground on its centralized counterparts from April to May alone Hyperliquid’s open interest
went up by nearly $20% jumping from around $3 billion to close to $9 billion making it
the fourth largest per platform meanwhile giants like Binance and Bybit together saw their
open interest shrink by about $6 billion during the same period so why exactly is Hyperlid so
popular well it’s basically a decentralized crypto exchange that feels like a centralized one but
that doesn’t require KYC letting traders easily access leverage in simpler terms it’s similar
to exchanges like Bybit and other perpetuals exchanges back in the last crypto cycle before
KYC became mandatory almost everywhere because of this Hyperlquid is quickly eating into the
market share of traditional centralized exchanges and we actually did a full deep dive into
Hyperlquid and you can watch it right over here but I digress so now that we’ve unpacked the
key insights from Galaxy’s leverage report there’s just one critical question remaining what does all
of this actually mean for the crypto market well it’s clear that leverage is set to play a bigger
role than ever before amplifying both the upsides and downsides in this cycle the crypto lending
market is recovering strongly from previous shocks and will likely grow significantly as the
bull market gathers steam for instance Coinbase’s moves to let people borrow against wrapped
versions of popular altcoins and other exchanges rolling out their own wrapped BTC products could
have the practical effect of pushing leverage in crypto markets to unprecedented heights on top of
that decentralized exchanges like Hyperlquid are making it easier than ever for traders to access
leverage through perpetual futures platforms offering nonkyc trading low fees and aggressive
leverage are attracting a growing wave of retail traders but folks here’s the crucial caveat
with more leverage comes more risk the rapid rise in leverage trading and borrowing both from
individual traders and leverage corporate entities means the next bare market could be especially
brutal as leverage positions inevitably start getting liquidated perhaps most worrying though
are those aforementioned crypto treasury companies firms like Strategy and its many imitators have
aggressively stacked BTC and other assets using debt if these companies don’t have sufficient
cash flows or their share prices slump they may be forced to liquidate their crypto holdings at
precisely the worst moment triggering widespread forced selling this interconnected leverage could
have severe marketwide consequences a liquidation spiral beginning with leverage traders in futures
markets and lending protocols could quickly spread eventually forcing treasury companies to
liquidate their holdings as well creating a domino effect that significantly amplifies
any market crash that said we’ll probably first see some explosive price moves to the upside as
more and more people pile in using leverage but just make sure you’re ready to exit before the
party inevitably comes to an end and that’s all
Add A Comment