What is Crypto Leverage?
By Beluga Research August 3, 2023
- Crypto leverage is the practice of using borrowed cryptocurrency to engage in trades
- An investor who makes a profit with crypto leverage can gain trading power, while an investor who sustains a loss with crypto leverage can lose trading power
- A broker or exchange can charge fees and set margin requirements relating to crypto leverage
- An investor must utilize crypto leverage in a manner that is consistent with the rules of the community in which they are trading
Crypto leverage is the practice of using borrowed cryptocurrency to engage in trades. It is a method of engaging with a cryptocurrency ecosystem to amplify one's trading power. The practice of crypto leverage involves borrowing cryptocurrency to have more cryptocurrency to trade.
The idea of crypto lending came from the world of traditional finance. Crypto leverage is popular with experienced traders who want to take advantage of the high volatility of the cryptocurrency market.
A Brief History
The concept of crypto leverage emerged in the early 2010s, with the rise in popularity of cryptocurrencies. Use of the practice has grown rapidly, as some exchanges offer leverage up to 100%.
Parties who have succeeded with utilizing leverage in the traditional finance world may have an advantage in working with the concept of crypto leverage. This is because the parties understand how to work under stress and in volatile environments. They know to follow trends regarding concerns in the crypto ecosystem. They are also aware of the dangers of the misuse of crypto leverage. One concern is too many parties in a crypto community assuming a great deal of risk and trying to make a large profit at the same time.
What is Crypto Leverage?
Crypto leverage is a practice that involves traders borrowing funds from an exchange or broker to increase their trading capital. A trader who is successful in the marketplace can increase trading power. Crypto leverage allows an investor to temporarily magnify trading power in an attempt to maximize profit.
The amount of leverage available varies between exchanges and brokers. Some exchanges and brokers provide up to 100x leverage. In this scenario, a trader that has $1,000 in a trading account can use 100x leverage and enter a position worth $100,000.
Leverage trading is facilitated by margin trading. This is the practice of borrowing funds to trade. The borrowed funds are used as collateral. The trader must maintain a certain level of margin to keep a position open. If the position moves against the trader, the exchange or broker may liquidate the position to cover the losses.
- Choose a reputable exchange or broker that offers leverage trading. It is important to choose a platform that is regulated and has a good reputation in the industry.
- Consider the fees and margin requirements of the platform. A trader should consider the range of assets available for trading.
- Deposit funds into an account and choose the asset to trade. The trader should select the leverage level they want to use. Higher leverage levels can increase the potential profit. They can also amplify the risk of loss.
- High volatility of the crypto market. Cryptocurrencies can experience rapid price fluctuations. This can lead to significant gains or losses for leveraged traders.
- Availability of margin funding. In traditional markets, margin funding is typically provided by brokers. In the crypto market, margin funding is often provided by other traders. Traders who offer margin funding can earn interest on idle funds by providing funds to other traders.
- Unique tax implications . In many jurisdictions, profits from leveraged trades are treated differently when compared to profits from traditional trades. A trader should consult with a tax professional to ensure they are compliant with local tax laws.
- Increased potential for profit. Using leverage can amplify the amount of profit that traders can make from a trade. For example, if a trader invests $1,000 in a cryptocurrency and the price goes up by 5%, they would make a profit of $50. However, if they used 10x leverage, they would be able to invest $10,000 in the same cryptocurrency. They would make a profit of $500 if the price goes up by 5%.
- Access to more trading opportunities. Leverage allows traders to access more trading opportunities than they would be able to with their own funds. For example, say a trader has $1,000 to invest in a cryptocurrency and the minimum investment size is $10,000. The trader would not be able to invest in that cryptocurrency without leverage. With leverage, they could borrow the additional funds needed to invest in the cryptocurrency.
- Lower capital requirements. Leverage allows traders to invest in cryptocurrencies with lower capital requirements. Traders who do not have a large amount of capital can still participate in the cryptocurrency market and potentially make a profit.
- Hedging. Leverage can be used for hedging purposes. For example, say a trader holds a long position in a cryptocurrency and is concerned that the price will fall. They can leverage to take a short position to offset any potential losses.
- Increased risk of losses. Leverage can amplify profits and losses. If a trader invests $1,000 in a cryptocurrency and the price goes down by 5%, they will lose $50. If they use 10x leverage, they will lose $500 if the price goes down by 5%. Traders should take care when using leverage. This will ensure that they have a solid risk management strategy in place.
- Margin calls. When using leverage, a trader needs to maintain a certain amount of equity in an account to cover their position. If the value of a position falls below this amount, there may be a margin call from the broker. The trader will then be required to deposit additional funds to cover the position. If a trader is unable to meet the margin call, the position may be liquidated. This means a trader may suffer a substantial loss.
- Higher fees. Brokers may charge higher fees for leveraged trading. These can eat into a trader's profits. Traders need to be aware of the fees associated with leveraged trading. They should factor them into their trading strategy.
- Psychological pressure. Leverage can create psychological pressure for traders. When trading with leverage, traders may feel more pressure to make the right decisions. They may be more prone to making emotional decisions.