What Is Leverage in Crypto Trading?

The concept of leverage has been used in other financial markets in various contexts, ranging from trading stocks to derivatives and even cryptocurrencies. The main purpose of leverage is to increase the opportunity for returns, whether in business, personal finance, or investments. However, it should only be used after understanding its pros and cons clearly.

Also Read: Cryptocurrency Regulations Worldwide

What Is Leverage in Crypto Trading

Leverage is the utilisation of borrowed capital to engage in the trading of financial assets, including cryptocurrencies. By employing this strategy, one can augment their purchasing or selling capacity, enabling them to execute trades with a larger capital amount than what is presently available in their wallet. Depending on the specific cryptocurrency exchange employed, individuals may have the ability to borrow funds up to 100 times their current account balance.

Leverage is normally expressed as a ratio such as 1:5 or 1:20. For instance, if the trader has $100 in the exchange account and wants to open a $1000 BTC position, he or she would require 10x leverage to give them the buying power of $1000. Leverage can be used to trade different crypto derivatives. Some of the common types of leveraged trading include futures contracts, leveraged tokens, and margin trading. 

How Does Crypto Leverage Trading Work?

Before one can borrow the funds required and start leverage trading, they need to deposit funds into their trading account. This initial capital is termed as collateral. Collateral requirements depend on the leverage the trader uses and the total value of the position (Margin). For instance, if a trader wants to invest $1,000 in ETH using 10x leverage, they would require a $100 margin as collateral.

Traders have to maintain a margin threshold for their trades aside from the initial margin deposit. They would need to put more funds into their account if the market moves against their position and the margin moves below its maintenance threshold.

With leverage, traders can buy or sell assets based only on their collateral and not on their holdings. This allows them to borrow and sell assets even if they don’t currently own them. That means they can profit if the price decreases.

Related: What Is Crypto Lending, and How Does It Work?

Why Do Traders Use Leverage to Trade Crypto?

Leverage trading is mainly used by traders to increase their position size and potential gains. However, leverage is always described as a double-edged sword. Keeping in mind the volatile nature of cryptocurrencies, leveraged trading can also result in significant losses if one is not careful.

Another important reason that traders use leverage is to enhance their capital liquidity. For instance, a trader can use 4x leverage to maintain a position with lower collateral instead of holding a 2x leveraged position.

Types of Leverage in Crypto Trading

There are many types of cryptocurrency leverage trading being practised, depending on a trader’s preferences.

Margin Trading

With margin trading, traders can borrow funds from a cryptocurrency exchange or a P2P lending platform. They can thus leverage their existing capital to amplify their buying power. By using these borrowed funds, traders can increase their profits by opening larger positions. Margin trading can also magnify losses if the market moves against the trader.

Futures Contracts

Futures Contracts refer to specific derivative financial instruments that allow traders to speculate on the future price movements of cryptocurrencies without owning any underlying assets. Futures trading involves using leverage to control a larger position with a smaller capital. They usually possess predetermined leverage ratios such as 10x or 20x.

Leveraged Tokens

Leveraged tokens are unique tokens designed to provide leveraged exposure to a particular cryptocurrency or asset. They track the price movement of the underlying asset with a leveraged multiplier such as 3x or 5x. These tokens are normally issued by crypto exchanges, which allow traders to gain leveraged exposure without directly engaging in the margin trading process.

Managing Leverage Trading Risks

Using high leverage might require less starting capital, but it enhances the liquidation risk. If the leverage is too high, even a 2% increase in price can result in huge losses. On the other hand, lower leverage gives traders a wider margin of error. This is one of the reasons why limits are imposed on the maximum leverage available to new users by the cryptocurrency exchanges themselves.

There are a number of risk management strategies to minimise losses in leveraged trading. For instance, traders can use stop-loss orders to automatically close their positions at a specific price. This strategy is especially useful when the market moves against the trader. On the other hand, take-profit orders can automatically close themselves when profits reach a certain level. This allows traders to secure their earnings before market conditions change.

Conclusion

Leverage trading can make or break a trader if they aren’t careful. While leverage can be used properly to produce huge profits, it can also produce big losses if the trader is unable to properly manage the risks. Traders are advised to start crypto leverage trading only after understanding the full consequences of it, especially in the highly volatile crypto market.

Frequently Asked Questions

Which Crypto Exchanges Provide Crypto Leverage Trading?

Some of the crypto exchanges that provide crypto leverage trading include Bybit, StormGain, and Binance. Bybit and StormGain offer up to 100x and 500x leverage, respectively, while Binance offers up to 125x leverage on USD-M and Coin-M futures contracts and up to 20x leverage on margin trading.

Is Crypto Leverage Trading Riskier Than Stock Leverage Trading?

Crypto leverage trading is riskier than stock leverage trading due to the nature of the assets in question. Cryptocurrencies are more volatile and have lower leverage limits compared to stocks. Cryptocurrencies also have higher fees than stocks, which can eat into profits.

Do I Need to Be an Expert Trader for Crypto Leverage Trading?

Crypto leverage trading is not suitable for beginners who are unfamiliar with the crypto market, the trading platforms, the technical analysis tools, and the risk management strategies.