The loop
Some lending markets accept PTs as collateral. A holder deposits PT, borrows a stablecoin or the accounting asset against it, buys more PT with the loan, deposits that too, and repeats. Each round adds exposure; the total is limited by how much the market lends against the collateral.
With a loan-to-value ratio of L, the most a loop can reach is 1 / (1 − L) times the starting capital: 5 times at 80%, 10 times at 90%. In practice it stops short of that, because the last rounds would leave no room before liquidation.
What it earns
The capital earns the PT's fixed rate on every unit of PT held and pays the borrow rate on every unit borrowed. At leverage x, the yearly result is roughly the fixed rate times x, minus the borrow rate times (x − 1), before costs. The fixed rate is fixed; the borrow rate usually is not. If the borrow rate rises above the PT's rate, each round of the loop subtracts instead of adding.
The health factor and liquidation
Every lending market sets a liquidation threshold, which Morpho calls the LLTV. A loan stands while its debt is below the collateral's value times that threshold. The health factor is the ratio of the two: collateral value × threshold ÷ debt. When it falls below 1, anyone may repay some or all of the debt (how much depends on the market) and take collateral at a discount for doing so. That is a liquidation.
The collateral's value is the price the market's oracle reports for the PT, not the price in Pendle's pool at that moment. How the oracle is built decides what can liquidate a loop; the next article is about that.
How little it takes
At high leverage the room is small. A loop at 10 times on a market with a 91.5% threshold has a health factor of about 1.017 (10 × 0.915 ÷ 9): a fall of 1.6% in the oracle price brings it to 1. A loop at 3 times on the same market starts at 1.37 and needs a fall of about 27%.
Time moves both sides. Interest accrues on the loan continuously, while the oracle price of the PT rises toward one unit as maturity nears. A loop left alone drifts toward its threshold when the borrow rate is above the PT's rate, and away from it when it is below.
The way out
Unwinding a loop before maturity means selling PT into the pool to repay the loan, round by round, at that day's price. At or after maturity the PT can instead be redeemed at its full value; before then, the ways out are selling it or merging it with YT. A research note here describes a morning on which a few trades moved a PT oracle far enough to liquidate two markets' most leveraged loops.