Risks and Implications of Crypto Collateralization in Margin Trading

The use of crypto assets as collateral in margin trading has long been a double-edged sword. While it enables liquidity and leverage, it also exposes traders to systemic risks tied to volatility, illiquidity, and regulatory uncertainty. Recent developments at Bybit-specifically the discontinuation of KDA, OMNI, and SLP as collateralizable assets-highlight the fragility of relying on volatile or depreciating tokens in leveraged positions. This article examines the strategic risks of such practices, contrasts them with the stability of centralized stablecoins like USDT and USDC, and offers actionable strategies for risk mitigation.

Bybit's Exit from Volatile Collateral: A Market Signal

Bybit's decision to discontinue KDA, OMNI, and SLP as collateralizable assets reflects a broader industry shift toward risk-averse collateral standards. The platform removed SLP on April 10, 2025, OMNI on September 26, 2025, and KDA on October 24, 2025, citing "ongoing efforts to adjust asset offerings and risk management protocols" according to platform announcements. These tokens, often algorithmically or seigniorage-pegged stablecoins, are inherently prone to liquidity crises and peg instability, particularly during market stress. Bybit's moves signal a growing preference for assets with predictable value retention, such as BTC, ETH, and centralized stablecoins.

This trend is not unique to Bybit. Across the crypto ecosystem, platforms are tightening collateral requirements to avoid the cascading liquidations seen in 2022 and 2023. For instance, the October 10, 2025, futures market crash triggered $19 billion in liquidations, driven by sharp price declines and mechanical deleveraging. Volatile assets like KDA and SLP, which lack robust reserve backing, are disproportionately vulnerable to such events.

The Stability Premium of Centralized Stablecoins

Centralized stablecoins like USDT and USDC have emerged as the preferred collateral in leveraged trading. By Q3 2025, they accounted for over 80% of onchain lending, up from 53% in Q4 2021. Their dominance stems from their fiat-backed nature, which ensures resilience during external shocks. For example, USDT and USDC typically trade at small premiums to $1, supported by liquid reserves and arbitrage mechanisms. This contrasts sharply with crypto-collateralized stablecoins like DAI, which face systemic risks due to embedded leverage and onchain liquidation dynamics according to research.

Data from Q3 2025 underscores their reliability: USDT's daily trading volume reached $200 billion, while USDC's ranged between $5 billion and $40 billion according to market analysis. Their widespread adoption by institutions-such as Binance's large transfers-further reinforces their role as low-risk collateral according to market analysis. However, even centralized stablecoins are not without risks. Counterparty exposure to issuing institutions (e.g., Tether or Circle) remains a concern, though these risks are generally lower than those associated with algorithmic stablecoins.

Liquidation Risks from Illiquid/Depreciating Assets

The 2025 market environment has exposed the dangers of leveraging illiquid or depreciating assets. For example, real estate funds and hedge funds have struggled with liquidity mismatches amid rising interest rates, forcing forced sales of illiquid assets to meet redemption requests. Similarly, the 2024 European Central Bank report highlighted how non-banking financial institutions (NBFIs) face amplified risks when leveraged positions are tied to illiquid assets like exotic options or private equity.

In crypto, the collapse of FTX in 2022 and the 2025 perps liquidation event demonstrate how rapid liquidity loss in volatile assets can trigger systemic stress. Illiquid tokens like KDA, OMNI, and SLP-once popular for their perceived yield potential-now exemplify the perils of over-leveraging. Bybit's discontinuation of these assets underscores the platform's recognition of their inherent instability.

Strategic Recommendations for Collateral Management

To mitigate these risks, traders and institutions should adopt the following strategies:

1. Prioritize Collateral Quality: Favor centralized stablecoins (USDT, USDC) and major blue-chip assets (BTC, ETH) over volatile or algorithmic tokens. These assets offer greater liquidity and peg stability, reducing exposure to cascading liquidations according to industry analysis.

2. Adopt Conservative Leverage Ratios: Limit leverage to 3–5x to buffer against sudden price swings. High leverage exacerbates liquidation risks, particularly in volatile markets according to research.

3. Diversify Positions: Avoid overconcentration in correlated assets. Diversification across asset classes and collateral types can reduce systemic risk according to research.

4. Implement Stop-Loss Orders: Automate risk management tools to limit downside exposure during rapid price declines according to research.

5. Monitor Regulatory Clarity: Centralized stablecoins, while stable, remain subject to regulatory scrutiny. Traders should stay informed about developments affecting issuers like Tether or Circle according to analysis.

Conclusion

The discontinuation of KDA, OMNI, and SLP as collateral by Bybit is a cautionary tale for the crypto industry. As leveraged trading evolves, the reliance on volatile or illiquid assets will increasingly be seen as a liability rather than an advantage. Centralized stablecoins offer a more resilient alternative, but their use must be paired with disciplined risk management. In a market where liquidity can vanish overnight, the priority must shift from maximizing leverage to ensuring survival.