FOLLOW THE MECHANISM
- 1Equity
The user supplies initial capital.
- 2Borrow
Debt expands the assets or exposure controlled.
- 3Revalue
Price moves change assets while debt follows its own rules.
- 4Unwind
Assets must be sold or returned to satisfy obligations.
A conceptual sequence. Real implementations can add steps, intermediaries, and conditions.
Start with assets minus liabilities
Equity is the residual value after subtracting debt or other obligations from assets. If a position controls 200 of assets with 100 of debt, its equity is 100 and its asset-to-equity leverage is two times. Different markets use different leverage labels, so the ratio must be stated. A borrower can have overcollateralized individual loans while still carrying substantial economic leverage across a larger portfolio. Collateral coverage describes lender protection; it does not remove amplified exposure for the borrower.
A simple price move
Take the illustrative position with 200 of one volatile asset and debt fixed at 100 reference units. A 10% asset-price decline reduces assets to 180 and equity to 80: a 20% equity loss before interest and fees. A 10% rise instead raises equity to 120. This symmetry is only local. Liquidation, transaction costs and debt denomination can change the path, and adverse price jumps can exhaust equity before a planned exit is possible.
Recursive deposits multiply gross claims
A loop can supply an asset, borrow against it, exchange the proceeds for more collateral and repeat. Each new deposit is supported partly by debt. In an idealized model that repeatedly reuses a fraction L of collateral value, gross collateral approaches initial equity divided by (1 − L), if L is below one. This geometric-series result ignores interest, costs, caps and liquidation buffers. It explains why several large deposit balances can sit on top of a much smaller original capital contribution.
Stress propagates through the exit
When prices fall or borrowing costs rise, leveraged positions may need to sell assets to reduce debt. Sales can worsen prices and affect other positions sharing the collateral, oracle or liquidity pool. A receipt token can also decline relative to its underlying asset, breaking an assumed hedge. Calling a strategy market neutral does not establish that its collateral, funding and execution risks cancel. To understand leverage, draw the consolidated balance sheet and follow the assets needed to repay every obligation.
MAKE IT CONCRETE
Illustrative recursive limit
With 100 initial equity and a frictionless 50% reuse fraction, the sequence of deposits is 100 + 50 + 25 + … = 200. Debt approaches 100. The extra 100 is an obligation, not newly created wealth.
FAILURE PATHS & COMMON MISREADINGS
Where the model can break
- Overcollateralized loans can still create a leveraged portfolio.
- A profitable final-price scenario can still be liquidated on the path.
KEEP EXPLORING