What is "leverage" in crypto trading? How can you profit from it?

Leverage in crypto trading is the trading of cryptocurrency or other financial assets using borrowed funds. Your purchasing or selling power is increased, allowing you to transact with more money than you presently have in your wallet. You will be able to borrow up to 100 times your account balance depending on the cryptocurrency exchange you use to trade.

A ratio is used to describe the amount of leverage, such as 1:5 (5x), 1:10 (10x), or 1:20 (20x). It displays the multiplicity of your starting capital. Consider opening a INR 1,000 BTC position with INR 100 in your exchange account as an illustration. Your INR 100 will have the same purchasing power as INR 1,000 with a 10x
leverage.

Leverage may be used to trade various crypto derivatives. Margin trading, leveraged tokens, and futures contracts are some of the popular forms of leveraged trading.

How does leveraged trading work?

You must make a deposit into your trading account before you can borrow money and begin using leverage. We refer to the first capital you offer as the collateral. Your usage of leverage and the overall amount of the position you seek to open will determine the collateral needed (known as margin).

Let's say you wish to use a 10x leverage and buy INR 1,000 in Ethereum (ETH). As a result, you would need INR 100 in your account as collateral for the borrowed money as the needed margin is one-tenth of USD 1000. Your necessary margin would be considerably smaller if you used a 20x leverage (1/20 of INR 1,000 =
INR 50).

But keep in mind that the chance of being liquidated increases with increasing debt. You'll need to have a margin threshold for your transactions in addition to the initial margin deposit. You will need to add additional money to your account if the market swings against your position and the margin falls below the maintenance barrier in order to keep your position from being liquidated. The maintenance margin is another name for the threshold.

You may use leverage for both long and short situations. Opening a long position indicates that you anticipate an asset's price to rise. Opening a short position, on the other hand, indicates your expectation that the asset's price will decline. While this could appear to be standard spot trading, utilising leverage enables you to
purchase or sell assets based solely on your collateral and not your holdings. Therefore, even if you don't own an asset, you may still borrow one and sell it if you believe the market will decline (take a short position).

Example of a leveraged long position

Consider that you wish to start a long trade in Bitcoin worth ₨10,000 with a 10x leverage. This implies that you will put up INR 1,000 as security. You will make a net profit of INR 2,000 (after fees) if the price of bitcoin increases by 20%, which is far more than the INR 200 you would have made if you had traded your INR 1,000 without leverage.

However, your stake would lose INR 2,000 of the price of BTC decreases by 20%. With merely INR 1,000 as your beginning capital (collateral), a 20% decline would result in a liquidation (your balance goes to zero). In fact, even a 10% decline in the market might cause you to be liquidated. The exchange you are utilising will
determine the precise liquidation value.

You must put extra money in your pocket to raise your collateral if you want to avoid getting liquidated. The exchange will often notify you of a margin call before the liquidation occurs (e.g., an email telling you to add more funds).

Example of a leveraged short position

Let's say you want to start a INR 10,000 short bet on Bitcoin with a 10x leverage. In this scenario, you would borrow Bitcoin from someone else and then sell it for the going rate. You have a INR 1,000 deposit as collateral, but thanks to your 10x leverage, you can sell INR10,000 worth of bitcoin.

You borrowed 0.25 BTC and sold it, assuming the price of Bitcoin at the time was INR 40,000. You may purchase 0.25 BTC back with only INR 8,000 if the price of Bitcoin falls by 20% (to INR 32,000). You would make a net profit of INR 2,000 as a result (minus fees). To purchase back the 0.25 BTC, you would need an additional INR 2,000 if BTC rose 20% to INR 48,000. Since there is just INR 1,000 left on your account, your position will be liquidated. Once more, you need to enhance your collateral before the liquidation price is reached in order to prevent being liquidated.

Why use leverage to trade crypto?

Leverage is a tool used by traders to raise the size of their positions and possible gains. But as the aforementioned instances show, using leverage in trading can also result in far bigger losses.

Leverage is another factor that traders employ to increase the liquidity of their money. For instance, they may utilise 4x leverage to maintain the same position size with less collateral instead of keeping a 2x leveraged position on a single exchange. The other half of their funds might then be used in various ways, such as investing in NFTs, staking, trading other assets, or supplying liquidity to decentralised exchanges (DEX).

Pros of Leverage Trading for Crypto

Leveraged trading has a lot of benefits, including the following:

1. Exposure to multiplied profits: Compared to a traditional transaction, you can make a lot more money with a fraction of the investment.
2. Increasing investments: This is because it releases money that could have been used for further investments. Gearing is another term for this capacity to enhance the cash available for additional investments.
3. Maximize your firm investment: If you are confident in your decision, you may raise your holdings with less money.

Conclusion

With a reduced initial commitment and the possibility for greater rewards, leverage in crypto trading makes it simple to get started. Even yet, liquidations could occur fast if leverage is used in conjunction with market volatility, particularly if you are using 100x leverage when trading.

Before engaging in leveraged trading, use prudence and weigh the dangers. Never trade with money you can't afford to lose, especially if you're utilising
leverage.

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