Leverage & Crypto Trading Explained

17 July 2023

8m read

Leverage in cryptocurrency trading refers to placing trades with borrowed funds. Trading using leverage can increase your buying or selling power and enable you to transact larger sums. As a result, you can use leveraged transactions even if your starting capital is tiny by using it as collateral.
Leverage trading can double your potential gains, but it also carries a considerable risk, particularly in the erratic cryptocurrency market. When trading cryptocurrency, use caution as utilizing leverage could result in significant losses if the market goes against your position.

Introduction ##
Trading with leverage can be challenging, especially for newcomers. Although a large percentage of the knowledge is equally applicable to regular markets, this post will focus on leverage trading in cryptocurrency markets.

What Does Leverage Mean in Cryptocurrency Trading?
Leverage is the trading of financial assets, such as cryptocurrency, using borrowed money. Your purchasing or selling power is increased, allowing you to transact with more money than you presently have in your wallet. You could be able to borrow up to 100 times your account balance depending on the cryptocurrency exchange you use to trade.
Leverage is expressed as a ratio that indicates how many times your initial capital is multiplied, such as 1:5 (5x), 1:10 (10x), or 1:20 (20x). A 10x leverage, for instance, will make $100 into $1,000 if you have $100 in your exchange account and wish to initiate a trade worth $1,000 in bitcoin (BTC).
Leverage can be used to trade various crypto derivatives. Margin trading, leveraged tokens, and futures contracts are some of the popular forms of leverage trading.
How Does Trading With Leverage Work?
You must make a deposit into your trading account before you can borrow money and begin using leverage. Collateral is the first capital you contribute. Your usage of leverage and the total amount of the position you wish to open (also known as margin) will determine how much collateral is needed.
Let's say you wish to use 10x leverage to buy $1,000 in Ethereum (ETH). As collateral for the borrowed money, you would need to have $100 in your account, or 1/10 of $1,000, as the needed margin. Your necessary margin would be considerably smaller if you used 20x leverage (1/20 of $1,000 = $50). But keep in mind that the danger of liquidation increases with increasing leverage.
You must maintain a margin threshold for your trades in addition to the initial margin payment. You'll need to add more money to your account to prevent liquidation if the market swings against your position and the margin falls below the maintenance threshold (also known as the maintenance margin).
Opening a long position indicates that you anticipate an asset's price to increase. Opening a short position, on the other hand, indicates that you think the price will decline.
With the aid of leverage, you are able to purchase or sell assets based solely on the value of your security. This implies that even if you don't currently own the assets, you can borrow them and sell them (start a short position). By doing this, you have the opportunity to make money if the price drops.

An illustration of a long leveraged position

You will use $1,000 in collateral to open a long position worth $10,000 in bitcoin with a 10x leverage. You will make a net profit of $2,000 (after fees) if the price of bitcoin increases by 20%, which is far more than the $200 you would have made if you had traded your $1,000 in unleveraged BTC.
However, your stake would lose $2,000 if the price of BTC decreases by 20%. With only $1,000 in beginning capital (collateral), a 20% decline would result in liquidation (your balance would be zero). In fact, even a 10% decline in the market could result in liquidation for you. The exchange you use will determine the precise liquidation value.
You must enhance your collateral in your wallet in order to avoid liquidation. Before liquidation, the exchange will typically give you a margin call (such as an email instructing you to add more funds).

A leveraged short position example

You must borrow bitcoin from a third party and sell it at the current market price in order to initiate a $10,000 short position on bitcoin with a 10x leverage. Since you are trading with a 10x leverage and only have $1,000 in collateral, you can sell $10,000 worth of bitcoin.
You would have borrowed 0.25 BTC and then sold it, assuming the price of Bitcoin is $40,000 at the moment. You can purchase 0.25 BTC back for only $8,000 if the price falls by 20% to $32,000. You would make a net profit of $2,000 (after fees) from this.
To buy back the 0.25 BTC, you would need an additional $2,000 if the price of BTC rose by 20% to $48,000. Due to the fact that your account balance is currently only $1,000, your position will be liquidated. Once more, you must increase your collateral before the liquidation price is reached in order to escape liquidation.

Why Trade Crypto With Leverage?

Leverage is a tool used by traders to raise the size of their positions and possible gains. But as the aforementioned examples show, using leverage in trading could also result in much bigger losses.
Leverage is also used by traders to increase their capital's liquidity. For instance, they may utilize 4x leverage to maintain the same position size with less collateral instead of holding a 2x leveraged position on a single exchange.
This would enable them to spend the remaining funds in various ways, such as trading different assets, staking, giving decentralized exchanges (DEX) liquidity, and making investments in NFTs.

How to Control the Risks of Leverage Trading

High leverage trading may require less initial cash, but it also raises your chance of liquidation. Your tolerance for volatility decreases as leverage increases; if your leverage is too great, even a 1% price change could result in significant losses.
On the other side, using less leverage provides you a larger margin of error. Because of this, many cryptocurrency exchanges place restrictions on the maximum leverage that new customers may utilize.
In leveraged trading, risk management techniques including stop-loss and take-profit orders assist reduce losses. When the market moves against you, stop-loss orders can be used to automatically close your position at a particular price. Stop-loss orders can shield you from big losses, but take-profit orders close when profits reach a certain level. By doing this, you can protect your earnings before the market situation changes.
Trading using leverage has two drawbacks: it can enormously increase both your profits and losses. It carries a significant amount of risk, particularly in the erratic cryptocurrency market. Binance promotes responsible trading as a result by holding users accountable for their activities.
Additionally, it provides customers with tools to assist them exercise control over their trades, such as a cooling-off period feature and an anti-addiction warning. Always remember to DYOR, learn how to handle leverage appropriately, and prepare your trading tactics. Traders should always proceed with the utmost caution.

Concluding Remarks

With leverage, you can start trading with a smaller initial investment and have a larger chance of making a profit. Even so, applying 100x leverage could result in a quick liquidation if market volatility is combined with leverage.
Always exercise caution when trading and consider the dangers before using leverage. Never trade with money you can't afford to lose, especially if you're utilizing leverage.

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