DeFi looping vs. leveraged long: which strategy is best for your crypto goals

When it comes to investing in cryptocurrency, two popular strategies for profiting from an asset’s price increase are DeFi looping and leveraged trading on exchanges. Both strategies allow you to amplify potential returns, but they differ fundamentally in purpose. Leveraged trading helps you earn more dollars (or stablecoins) from an asset’s growth. Looping, on the other hand, is a strategy designed to increase the amount of the crypto asset itself, such as Ethereum. Your ultimate goal will determine which strategy is best for you: Do you want to accumulate more crypto, or lock in your profits in stablecoins?

What is Leveraged Trading? 📈

Leveraged trading is a popular strategy that allows you to borrow funds and increase your exposure to an asset’s price movements. Using leverage enables you to open a position much larger than your initial capital, or margin. This amplifies your potential profits if the asset moves in your favor but also magnifies your losses if the price moves against you.

The primary purpose of a leveraged long position is to profit from an asset’s price increase. Essentially, you are “buying” an asset with borrowed money, expecting its value to rise.

🔢 The Process: A Step-by-Step Example

Let’s illustrate the process with a hypothetical example on a centralized exchange like Bybit, where you can easily open a leveraged long position. For this example, we’ll use a 5x leverage on Ethereum (ETH) with your initial capital of $2,000.

Deposit Your Collateral: You start by depositing your own funds, known as collateral or margin, into your Bybit account. In this case, you deposit 2,000 USDT.
Borrow Funds: You decide to open a 5x leveraged long position on ETH. The exchange lends you funds equal to four times your collateral.

Your capital:
$2,000
Borrowed funds:
$8,000
Total position size:
$10,000
Open the Position: With a total position of $10,000, you “buy” ETH. Let’s assume the current price of ETH is $1,000. Your position size of $10,000 allows you to control 10 ETH.
Price Rises & You Close the Position: The price of ETH rises by 50%, from $1,000 to $1,500. Your 10 ETH position is now worth $15,000 (10 ETH x $1,500). To realize your profit, you close the position.

Final position value:
$15,000
Initial borrowed funds:
$8,000
Profit:
$5,000
Final Tally: The exchange automatically repays its $8,000 loan from your final position value. You are left with your initial collateral plus the profit.

Your initial capital:
$2,000
Profit:
$5,000
Total in your accoun:
$7,000

As you can see, a 50% increase in ETH’s price resulted in a 250% return on your initial capital ($5,000 profit on a $2,000 investment). Note: This is a simplified, hypothetical example. It does not account for exchange fees, slippage, or funding rates on perpetual futures, all of which would slightly reduce the final profit. These factors have been excluded in order to focus on the core mechanics of the strategy.

⚠️ The Risk of Liquidation

While the profit potential is high, so is the risk. The primary risk of leveraged trading is liquidation.

When you open a leveraged position, the exchange automatically calculates a liquidation price. This is the price at which your position will be automatically closed by the exchange to prevent you from losing more money than your initial collateral.

In our example, if the price of ETH had dropped instead of rising, your position would have lost value. If the price reached a certain point (e.g., $800), your position would be automatically sold, and your entire initial capital of $2,000 would be lost.

What is Looping? ♻️

Looping is a decentralized finance (DeFi) strategy that allows you to create a leveraged long position on a crypto asset without using a traditional exchange. This “DIY” method involves repeatedly borrowing and re-depositing the same asset on a lending protocol like Aave.

The key purpose of looping is not to earn dollars, but to increase the total amount of a specific crypto asset you hold, such as ETH. You are essentially using the protocol to multiply your holdings of an asset you believe will appreciate in value long-term.

🔢 The Process: A Step-by-Step Example

Let’s illustrate the process of looping using Aave on a 2x leverage. This is a realistic leverage level for this strategy, as going much higher increases the risk of liquidation dramatically.

Deposit Your Initial Capital: You start by depositing your own funds as collateral into the Aave protocol. In this case, you deposit 2 ETH, assuming its price is $1,000 per ETH. Your collateral is worth $2,000.
Looping for Leverage: To get a 2x leverage, you need to use a series of borrowing and re-depositing cycles. The Aave protocol has a borrow limit, so you can’t borrow the full amount in one go. You’ll repeat the following steps until you reach your target position:
- Step 1: Borrow: Using your 2 ETH as collateral, you borrow stablecoins like USDT. Let’s say you borrow $1,000, which is 50% of your collateral’s value (a typical conservative LTV).
- Step 2: Buy More ETH: You take the borrowed $1,000 USDT and use it to buy more ETH on a decentralized exchange (DEX) like Uniswap. At the current price of $1,000 per ETH, you get 1 ETH.
- Step 3: Re-deposit: You deposit this new 1 ETH back into Aave as additional collateral. Now you have a total of 3 ETH in collateral.
- Step 4: Repeat: You can now repeat the cycle, borrowing more USDT against your expanded collateral (3 ETH), buying more ETH, and re-depositing. This process is repeated until you reach your target 2x leverage, which would result in a final position of 4 ETH in your collateral with a debt of $2,000.
Your initial capital:
$2,000 (2 ETH)
Final borrowed funds:
$2,000 (USDT)
Final position size:
$4,000 (4 ETH)
Price Rises & You Unwind the Loop: The price of ETH rises by 50%, from $1,000 to $1,500. Your 4 ETH collateral is now worth $6,000, but your debt remains at $2,000. To realize your profit and close the position, you “unwind the loop” by selling some of your ETH to repay the loan.

Initial Collateral Value:
$4,000
Loan amount:
$2,000
New Collateral Value:
$6,000
Final Tally: To pay off your loan, you sell a portion of your ETH. Amount of ETH to sell: $2,000 (debt) / $1,500 (new ETH price) = 1.33 ETH. Remaining ETH: 4 ETH - 1.33 ETH = 2.67 ETH

Your initial ETH:
2 ETH
Final ETH:
2.67 ETH
Profit:
0.67 ETH

You started with 2 ETH, so you’ve increased your total ETH holdings by 33.5%. Your profit is not in dollars (USDT), but in the asset itself.

⚠️ The Risk of Liquidation

The primary risk of looping, just like with leveraged trading, is liquidation. However, the mechanism is slightly different.

DeFi protocols like Aave constantly monitor the value of your collateral in relation to your borrowed amount. If the price of your collateral asset (ETH) drops and your loan-to-value (LTV) ratio becomes too high, your position will be automatically liquidated.

To avoid this, it’s critical to monitor your Health Factor. This is a single number that reflects the safety of your position. A higher number indicates a greater cushion against price drops. A Health Factor of 1.0 means your position is at the liquidation threshold. It is highly recommended to maintain a Health Factor of 1.5 or higher, with many experienced users aiming for 2.0 or more to stay safe from sudden market volatility.

When your position is liquidated, the Aave protocol does not just take your initial collateral. It automatically sells a portion of your collateral to repay the loan at a discounted price to incentivize liquidators. The remaining collateral is returned to your wallet. While you do receive a portion of your ETH back, the liquidation process often results in a significant loss, as your collateral is sold at a discount, and you incur a penalty fee. You can hope to buy back at a lower price later, but there is no guarantee you will “break even” or even have enough remaining ETH to do so easily.

Looping vs. leveraged trading: the key differences 🆚

On the surface, both looping and leveraged trading seem to serve the same purpose: they’re strategies for amplifying returns by using borrowed capital. However, despite this apparent similarity, they have fundamental differences in their process, risk profile, and, most importantly, their ultimate goal. Understanding these distinctions is crucial for choosing the right strategy for your investment objectives.

🔄✋ Looping requires more manual work

Leveraged trading on a centralized exchange is a simple, automated process. You deposit your collateral, select your leverage level, and the exchange handles the rest. It’s a single, fast transaction.

Looping in DeFi, on the other hand, is a multi-step process. To achieve your desired leverage, you have to perform a series of manual transactions: you borrow funds, swap them for the crypto asset, and then re-deposit that asset as collateral. While some services can automate this, it’s still an inherently more complex and costly process due to network gas fees.

🏋️‍♂️🚫 Leverage potential is limited with looping

Centralized exchanges offer extremely high leverage, often ranging from 50x to 100x. While this creates the potential for massive profits, it comes with an equally high risk of immediate liquidation.

In contrast, DeFi looping is limited by the protocol’s loan-to-value (LTV) ratio. A 2x leverage is often considered a healthy and relatively safe maximum. This means that while looping won’t give you the explosive, high-risk profit potential of a 100x trade, it also makes the strategy more stable and less prone to sudden, catastrophic failure from a small market fluctuation.

🎲 The risk profile is fundamentally different

When a leveraged trade on a centralized exchange goes wrong, a trader can lose their entire initial capital. In our example, if ETH had dropped by just 20%, your entire $2,000 would have been wiped out. This high risk is why most traders (over 90%) end up losing money over the long term.

With looping, you don’t lose your entire capital. If your position is liquidated, the protocol sells only a portion of your collateral to cover the loan, and you are left with the remaining balance. While you still incur a significant loss from the liquidation penalty, a portion of your ETH remains in your wallet.

💰🆚 The most important difference: your profit is in crypto, not FIAT

This is the key distinction between the two strategies and what makes looping so attractive to long-term investors.

With leveraged trading, your profit is in stablecoins. You open a position with USDT and, if successful, you close it with more USDT. The purpose is to increase your dollar holdings.

With looping, your profit is in the crypto asset itself. You start with ETH, and if successful, you end up with more ETH.

This difference is crucial if you are optimistic about an asset’s long-term growth. In our looping example, you turned your initial 2 ETH into 2.67 ETH. If ETH’s price rises again by another 50% from $1,500 to $2,250, your 2.67 ETH would be worth over $6,000. If you had taken profit in USDT with leveraged trading, you would have to buy ETH at the new, higher price of $2,250. Looping allows you to strategically accumulate more of the asset without having to buy back in at a higher price.

Final thoughts: which strategy is right for you? 🤔

The choice between looping and leveraged trading depends on your goals and risk tolerance.

Leveraged trading is a high-risk, high-reward strategy best suited for those looking for maximum profit potential in the short term. The goal is to increase your dollar holdings.

Looping is more of a long-term investment strategy. It is ideal for those who have a strong conviction in the strategic growth of a crypto asset and want to use leverage to increase their position over time. The goal is to accumulate more crypto.