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What Is Crypto Leverage Trading?

Leverage trading has been around long before cryptocurrency was invented. However, this high-risk trading technique has had an outsized influence on the prices of digital assets. Some critics claim leverage trading is one of the leading causes of the wild price action associated with cryptocurrencies. 

Despite the controversy surrounding crypto leverage trading, many exchanges still offer this feature to crypto traders. While crypto leverage trading has its uses, people must fully grasp the risks associated with this strategy before diving in.

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What is leverage trading?

No matter what market a trader is involved in, leverage trading means borrowing extra funds to increase a position’s size. Think of leverage as a loan issued by an exchange that instantly adds funds to your account. 

The only difference between crypto leverage trading and leverage in traditional markets is that the former involves cryptocurrencies. Crypto trading platforms that offer leverage trading usually allow customers to increase their position size on Bitcoin (BTC) and large-cap altcoins like Ethereum (ETH). 

People who take a leverage position in crypto should firmly believe that a digital asset will move up or down in a predetermined time frame. If the trade works out, the leverage will dramatically increase a person's gains. On the flip side, since this leverage is a loan, there are greater consequences if the trade doesn't work out. If a digital asset’s price moves in the opposite direction that a trader initially bet on, they can lose 100% of their capital. 

How to leverage trade crypto

While crypto leverage trading always involves a loan, the amount a trader can take isn't the same for every exchange. There are many ways traders can customize their crypto leverage trade to suit their risk tolerance. 

The amount of leverage you can take out is often expressed as a ratio. For example, someone who adds 1:10 leverage to their crypto trade will multiply their position by 10x. Interestingly, some crypto exchanges offer leverage positions of 1:100 or higher!

To open a leverage trade, you first need to deposit money or crypto into your trading account. This initial capital is known as collateral, which dictates how much leverage you can receive. 

Different crypto exchanges have unique margin requirements when taking out leverage. Margin refers to the collateral you need in your account to maintain an active leverage position. If the margin requirement doesn't meet the agreed-upon terms during the trade, the crypto exchange can legally collect your collateral (or liquidation). 

Example

To better illustrate these points, let's take a look at an example. 

Suppose you want to take out a 5x leverage position on Bitcoin. First, you'll deposit the required funds onto your crypto exchange and request the loan. If you deposited $5,000 in collateral, a 5x leverage position would give you $25,000. 

Remember, with a 5x leverage loan, the price of Bitcoin moves 5x more than on the spot market. So, if Bitcoin's price rose $100, it’ll garner $500 for you. It can also be in the opposite direction. If Bitcoin drops by $100, you’d be down $500. This means Bitcoin doesn’t have to drop to $0 for a leverage trader to lose all their money. If Bitcoin keeps going down, it’ll hit a point where a leverage trader has nothing left in their account. While leverage intensifies a trader’s gains, it also increases the odds that they can lose all their money on a price dip.  

While you can close your leverage position anytime, you must be wary of the margin requirement. If Bitcoin's price ever reaches the point where your account position hits the margin threshold, the crypto exchange will liquidate (i.e., sell off) all your funds. 

Leverage long and short positions

Traders can use crypto leverage to bet that a token’s price will increase or decrease. People who believe a coin's price will go up are taking a long position, while those who feel a token is due for a pullback will open a short.

Remember that you don't need to hold the underlying cryptocurrency to open a leverage long or short. Even if you don't have BTC in your account, you can trade it with leverage. You only need to deposit the required collateral into your exchange to open a leverage position. 

What are the risks?

This might sound like a disclaimer, but crypto leverage trading isn’t for risk-averse investors. This trading tool isn't designed for people only interested in holding tokens for the long haul. Anyone that wants a passive long-term investment strategy should avoid crypto leverage trading. 

Cryptocurrencies are already considered one of the riskiest asset classes due to their volatile nature. Adding leverage to the mix multiplies your risk. Not only that, but it's also far more likely people will lose all their money on a leverage trade versus simply buying a token on the open market. 

Although any cryptocurrency can go to zero, leverage traders can lose all their funds if a token moves just a few percentage points. Someone holding bitcoins still has purchasing power if it falls by 20%, but this move may force a long BTC leverage trader to get liquidated.

Remember, crypto liquidation means that the crypto exchange collects your collateral if you don't have the required margin in your account. This is generally called a margin call. 

If you're close to a margin call, the crypto exchange should send you warnings via email or push notifications. If you don't respond to these alerts, you’ll likely lose all your money. However, you can add more collateral to your account to avoid liquidation. Extra collateral will increase your margin requirements, which may buy you more time as you wait for a trade to play out. 

Although crypto leverage trading is inherently risky, there are tools traders use to assess how much they can lose. These risk management skills are crucial to preserving your capital if a trade goes sour. 

People trading cryptocurrency with leverage should calculate their risk/reward ratio. In other words, write down how much you hope to gain and are willing to lose with a leverage position. Also, factor in your margin requirement to determine what price would trigger a liquidation. 

After determining these price targets, leverage traders can set stop-loss and take-profit limit orders on their trading accounts. Both of these orders automatically sell their leverage position at a predetermined price. The only difference is that a stop-loss sells position at a loss, while a take-profit order sells for a gain. 

Stop-loss orders vs. take-profit orders 

Stop-loss orders save traders from facing liquidation. Instead of losing 100% of their position in a bad trade, a stop-loss guarantees they’ll only lose as much as they’re comfortable with. 

Take-profit orders, on the other hand, help traders avoid getting too greedy with a good trade. This will immediately kick in if a crypto price moves to their target, which ensures they’ll earn a profit. 

Learning these risk management skills is crucial for anyone considering margin trading. People who don't feel comfortable taking on these risks should stick with trading on the crypto spot market. 

Why use leverage trading?

People use leverage trading to increase their price exposure to a cryptocurrency. The more leverage they put on a crypto trade, the more they stand to gain if all goes well. As a trader, you don't need a large amount of cash to take out massive crypto positions, making leverage an alluring option.

Although people can make more money with a successful leverage trade, remember that there's no way to predict future price movements. Leverage trading is extra dangerous in crypto because the prices of digital assets are more volatile than stocks or precious metals. 

Where does leverage trading take place?

Most traders who use crypto leverage do so on a centralized exchange (CEX). A few of the most prominent cryptocurrency exchanges (at the time of writing) that offer crypto leverage services include: 

  • Binance
  • Bybit
  • FTX
  • Gate.io
  • Kraken
  • KuCoin

Every exchange has unique margin requirements and token availability, so new customers need to ensure their crypto trading platform fits their expectations. Something worth noting is that CEXs charge additional fees for leverage trading. Traders must factor in these trading fees when considering opening a leverage trade. 

Wrapping up

Leverage trading is a controversial aspect of the current crypto market. Although leverage grants traders easy access to extra capital, it adds volatility to the crypto market. When large numbers of crypto traders get liquidated, it tends to result in massive price spikes or falls.

You can likely lose all your collateral if you open a leverage position. Also, it would be beneficial to review limit order strategies like stop-losses and take-profits to effectively manage your risk. Leverage crypto traders should constantly monitor their position and turn on price alerts to avoid a margin call. 

At Worldcoin, we strongly encourage crypto investors to increasingly learn about safely buying, selling, and using crypto. We aim to put a share of our crypto in the hands of every individual on the planet for free while maintaining their privacy and anonymity. Subscribe to our blog to understand topics such as crypto wallets, NFTs (non-fungible tokens), and two-factor authentication and the ins and outs of the cryptocurrency market.

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