Over the last 24 hours, DeFi platforms have shaken off $662 million in loans, led by the Binance Smart Chain lending application Venus, Aave (versions 1 and 2) and Compound, Debank data shows.
When major cryptocurrencies lose a large amount of value on the spot market, it can cause many corresponding positions, such as bullish bets in the form of derivatives and loans, to unwind rapidly. That can prolong a sell-off and drive the pain deeper, if temporarily.
Highly financialized markets can accelerate downturns, noted Taylor Monahan, founder of wallet provider MyCrypto.
"Leveraged positions get liquidated at humanly psychological barriers (40k / 3k) and when that collateral is liquidated, it drives the price down more, which triggers more liquidations which then sell at market, which drives the price down more, which triggers more liquidations," Monahan wrote in an email.
In DeFi, users can borrow assets without credit checks because they supply ample collateral. If the value of the collateral drops below the minimum to keep the loan current, third-party liquidators can trigger a function that sells the collateral off, levying a hefty liquidation fee on the borrower. Once the loan and fees are paid, the remainder returns to the borrower.
It's a painful haircut, though, and borrowers often rush to close positions when the market falls. That may explain why some stablecoins, which normally trade around $1 by design, briefly traded above their peg on Wednesday.
Total value locked (TVL) in Ethereum-based smart contracts has fallen by $11 billion since Tuesday night, dropping to $66 billion, according to DeFi Pulse. On Binance Smart Chain, TVL is down by the same amount, falling to $29 billion worth of assets functioning as collateral, according to Defistation.
Over the last year, the second-worst day for liquidations came on Feb. 22, when $129.6 million was liquidated.
For comparison, last year's so-called Black Tuesday, March 11, which particularly shook the MakerDAO community, saw only $16 million in liquidations, with another $5.7 million the next day.
It's not clear exactly what caused the crypto market, led by bellwether bitcoin, to pull back. Various explanations include China's reiteration of trading restrictions or simply an overdue correction.
"My best guess is [investors are] simply deleveraging after a pretty euphoric period in the markets," said Nic Carter, a partner at Castle Island Ventures and co-founder of data provider Coin Metrics.
UPDATE (May 19, 17:40 UTC): Added background and a quote about broader crypto sell-off at the end.