This article is reprinted with permission from Wu Shuo Real, author: danny, copyright belongs to the original author.

Although this crash was ignited by Trump, its disastrous destructive power stems from the high-leverage environment within the native financial system of the cryptocurrency market. The high-yield stablecoin USDe, the recursive "circular lending" strategy built around it, and its widespread use as collateral by market participants such as market makers have collectively created a highly concentrated and extremely fragile risk node.

The price decoupling event of USDe was like the first domino, triggering a chain reaction of large-scale deleveraging that spread from on-chain DeFi protocol liquidations to centralized derivatives exchanges. This article will detail the operational principles of this mechanism from the perspectives of large holders and market makers.

1.1 Tariff Statement: Catalyst, Not Root Cause

The trigger for this market turmoil was Trump's tweet about tariffs. This statement quickly sparked a classic risk-averse reaction in global financial markets. This news became the catalyst for the initial sell-off in the market.

After the announcement of the tariff war, global markets fell in response. The Nasdaq index plummeted over 3.5% in a single day, and the S&P 500 index dropped nearly 3%. Compared to traditional financial markets, the reaction in the cryptocurrency market was much more severe. Bitcoin's price fell 15% from its intraday high, while altcoins experienced catastrophic flash crashes, with prices dropping 70% to 90% in a short time. The total liquidation of cryptocurrency contracts across the network exceeded $20 billion.

1.2 Existing Conditions: Market Accumulation Under Speculative Frenzy

Before the crash, the market was already permeated with excessive speculative sentiment. Traders generally adopted high-leverage strategies, attempting to "buy the dip" during each pullback to seek greater profits. Meanwhile, high-yield DeFi protocols represented by USDe rapidly emerged, attracting massive amounts of capital seeking returns with their ultra-high annualized yields. This led to the formation of a systemically fragile environment within the market, built on complex, interrelated financial instruments. It can be said that the market itself had become a powder keg filled with potential leverage, just waiting for a spark to ignite.

2.1 The Siren Song of Yield: The Mechanism and Market Appeal of USDe

USDe, launched by Ethena Labs, is a "synthetic dollar" (essentially a financial certificate), which had grown to a market capitalization of about $14 billion before the crash, making it the third-largest stablecoin globally. Its core mechanism differs from traditional dollar-backed stablecoins; it does not rely on equivalent dollar reserves but maintains price stability through a strategy called "Delta Neutral Hedging." This strategy specifically involves holding a long position in Ethereum (ETH) while shorting an equivalent amount of ETH perpetual contracts on a derivatives exchange. Its "base" APY of 12% to 15% primarily comes from the funding rates of perpetual contracts.

2.2 Building Super Leverage: Step-by-Step Analysis of Circular Lending

What truly pushed the risk to the extreme was the so-called "circular lending" or "yield farming" strategy, which could amplify annualized yields to an astonishing 18% to 24%. This process typically unfolds as follows:

• Staking: Investors use their USDe as collateral in a lending protocol.
• Borrowing: Based on the platform's loan-to-value (LTV) ratio, they borrow another stablecoin, such as USDC.
• Exchange: They exchange the borrowed USDC back to USDe in the market.
• Restaking: They deposit the newly acquired USDe back into the lending protocol, increasing its total collateral value.
• Looping: Repeat the above steps 4 to 5 times, amplifying the initial principal by nearly four times.

This operation may seem like rational capital efficiency maximization on a micro level, but on a macro level, it constructs an extremely unstable leverage pyramid.

To illustrate the leverage effect of this mechanism more intuitively, the following table simulates a hypothetical circular lending process with an initial capital of $100,000 and an LTV of 80%. (Data is not important; the logic is key.)

From the table, it can be seen that with just $100,000 of initial capital, after five rounds of looping, it can leverage over $360,000 in total positions. The core fragility of this structure lies in the fact that if the total value of USDe positions experiences a slight decline (for example, a 25% drop), it would be enough to completely erode 100% of the initial capital, triggering forced liquidation of positions far larger than the initial capital.

This circular lending model creates severe "liquidity mismatches" and "collateral illusions." On the surface, a massive amount of collateral is locked in the lending protocol, but in reality, the true, un-rehypothecated initial capital only accounts for a small portion of it. The total value locked (TVL) of the entire system is artificially inflated because the same funds are counted multiple times. This creates a situation similar to a bank run: when market panic ensues, all participants attempt to close their positions simultaneously, racing to exchange large amounts of USDe for the limited "real" stablecoins (such as USDC/USDT) available in the market, leading to a collapse of USDe in the market (although this may not be related to the mechanism).

3.1 Strategy Construction: Capital Efficiency and Yield Maximization

For "whales" holding large amounts of altcoin spot, their core demand is to maximize the yield of their idle capital without selling assets (to avoid triggering capital gains tax and losing market exposure). Their mainstream strategy is to stake their altcoins on centralized or decentralized platforms like Aave or Binance Loans to borrow stablecoins. Subsequently, they invest these borrowed stablecoins into the highest-yielding strategies available in the market at that time—namely, the USDe circular lending loop mentioned earlier.

This effectively constitutes a double-layer leverage structure:

• Leverage Layer 1: Borrowing stablecoins using volatile altcoins as collateral.
• Leverage Layer 2: Investing the borrowed stablecoins into the recursive loop of USDe, further amplifying leverage.

3.2 Initial Shock: LTV Threshold Alerts

Before the tariff news, the value of the altcoin assets used as collateral by these large holders was already in a state of unrealized loss, barely maintained by excessive margin; when the tariff news triggered the initial market decline, the value of these collateral altcoin assets also fell.

This directly led to an increase in their LTV ratio in the first layer of leverage. As the LTV ratio approached the liquidation threshold, they received margin call notifications. At this point, they had to either add more collateral or repay part of the loan, both of which required stablecoins.

3.3 In-Market (Exchange) Collapse: The Chain Reaction of Forced Liquidations

To respond to margin call requirements or proactively reduce risk, these large holders began to unwind their circular lending positions in USDe. This triggered immense selling pressure of USDe against USDC/USDT in the exchange market. Due to the relatively weak liquidity of USDe in spot trading on exchanges, this concentrated selling pressure instantly crushed its price, causing USDe to severely decouple on multiple platforms, with prices dropping to as low as $0.62 to $0.65.

The decoupling of USDe in the market produced two simultaneous devastating consequences:

• Collateral Liquidation: The plummeting price of USDe caused its value as collateral for circular lending to shrink instantly, directly triggering the automatic liquidation procedures within the lending protocol. The system designed for high yields collapsed into a massive forced sell-off within minutes.

• Spot Liquidation: For those large holders who failed to add margin in time, the lending platform began to forcibly liquidate their initially staked altcoin spots to repay debts. This selling pressure directly impacted the already fragile altcoin spot market, exacerbating the spiral decline in prices.

This process reveals a hidden, cross-domain risk contagion channel. A risk originating from the macro environment (tariffs) transmitted through lending platforms (altcoin collateral loans) to the spot market (USDe circular lending), where collateral liquidation was sharply amplified, and the consequences of its collapse simultaneously backfired on the stablecoin itself (USDe decoupling) and the spot market (altcoins being liquidated). The risk was not isolated within any single protocol or market segment but flowed freely across different domains through leverage as a transmission medium, ultimately triggering a systemic collapse.

4.1 Pursuing Capital Efficiency: The Temptation of Yielding Margin

Market makers (MM) maintain liquidity by continuously providing bid and ask quotes in the market, and their business is highly capital-intensive. To maximize capital efficiency, market makers commonly use the "Unified Account" or cross-margin model provided by mainstream exchanges. In this model, all assets in their accounts can serve as unified collateral for their derivatives positions.

Before the crash, using their market-making altcoins as core collateral (at varying collateral rates) to borrow stablecoins became a popular strategy among market makers.

4.2 Collateral Shock: The Failure of Passive Leverage and Unified Accounts

When the price of the altcoin collateral plummeted, the value of the accounts used as margin for market makers instantly shrank significantly. This produced a crucial consequence: it passively doubled their effective leverage ratio. A position originally considered "safe" at 2x leverage could overnight transform into a high-risk 3x or even 4x leverage position due to the collapse of the denominator (collateral value).

This is where the unified account structure became a vehicle for the collapse. The exchange's risk engine does not care which asset caused the margin shortfall; it only detects that the total value of the entire account is below the margin level required to maintain all open derivatives positions. Once the threshold is reached, the liquidation engine automatically activates. It does not only liquidate the already depreciated altcoin collateral but begins to forcibly sell any liquid assets in the account to cover the margin gap. This includes a large amount of altcoin spot held by market makers as inventory, such as BNSOL and WBETH. Moreover, at this time, BNSOL/WBETH was also being crushed, further dragging other originally healthy positions into the liquidation system, causing collateral damage.

4.3 Liquidity Vacuum: Market Makers as Victims and Contagion Vectors

While their accounts were being liquidated, the automated trading systems of market makers also executed their primary risk management directive: withdrawing liquidity from the market. They massively canceled buy orders across thousands of altcoin trading pairs to recoup funds and avoid taking on more risk in a declining market.

This created a catastrophic "liquidity vacuum." At the moment when the market was flooded with a large number of sell orders (from the collateral liquidations of large holders and the unified account liquidations of market makers), the primary buying support in the market suddenly vanished. This perfectly explains why altcoins experienced such severe flash crashes: due to the lack of buy orders on the order book, a large market sell order was enough to drive prices down by 80% to 90% within minutes until it reached some scattered limit buy orders far below the market price.

In this event, there was also a structural "catalyst," which was the liquidation bots for collateral. Once the liquidation threshold was reached, they would sell the corresponding collateral on the spot market, leading to further declines in the altcoin, which triggered more collateral liquidations (whether from large holders or market makers), resulting in a spiral liquidation event.

If the leverage environment is gunpowder, Trump's tariff war statement is the fire, then the liquidation bots are the oil.

Looking back at the entire causal chain of the event:

Macro shock → Market risk-averse sentiment → Liquidation of USDe circular lending positions → USDe decoupling → On-chain circular loan liquidations → Plummeting value of market maker collateral and soaring passive leverage → Liquidation of market maker unified accounts → Market makers withdrawing liquidity from the market → Collapse of the altcoin spot market.

The market crash on October 11 was a textbook case, profoundly revealing how the pursuit of extreme capital efficiency can introduce catastrophic, hidden systemic risks into the market through novel and complex financial instruments. The core lesson of this event is that the blurring of boundaries between DeFi and CeFi creates complex and unpredictable risk contagion pathways. When assets from one domain are used as collateral in another domain, a localized failure can quickly evolve into a crisis for the entire ecosystem.

This crash serves as a harsh reminder: in the crypto world, the highest yields often come with the highest and most concealed risks as compensation.

Understanding both the phenomenon and its underlying reasons, may we always hold a heart of reverence for the market.

Related: Hyperliquid whale denies insider trading with the Trump family

Original: “The Siren Song of Yields: How USDe Looping Triggered the Crypto Crash?”

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