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In the world of crypto and spot trading, leverage is regarded as a quick way to significantly boost your trading profits. Leverage allows traders to make more money from the borrowed funds during trading than they could have with their own small capital. In this way, leverage assists in the amplification of the buying and selling power of traders. While it increases profits, the risks it poses for crypto newbies makes it a double-edged sword.
What is Leverage in cryptocurrency?
Leverage, in the field of cryptocurrency trading, refers to using loaned capital to trade cryptocurrencies, stocks, or other assets. Leverage is used by traders or investors to boost the capital available to them so that they have more funds to trade with.
The amount of leverage is usually represented as ‘leverage ratio’, e.g. as 1:5 (🗙5), 1:10 (🗙10), or 1:20 (🗙20). For instance, the 1:5 ratio or 🗙5 leverage shows that the initial capital in the trader’s wallet will be multiplied 5 times and would thereby increase an amount of $100 to $500.
The leverage is provided by the broker or crypto exchange that the trader is using. Furthermore, depending upon the exchange used by the traders, the amount of leverage can vary from 1:1 to 1:500, or even more in some cases. As an example, on HitBTC traders could borrow money up to 100 times their actual wallet balance.
The leverage ratios for different token pairs also differ within the same exchange. HitBTC, for instance, offers 🗙10 leverage on BTC/USD while giving out only 🗙5 for SOL/ETH pair.
How does crypto leverage trading work?
The first step a trader needs to take before using leverage is to add funds to their crypto exchange account as ‘collateral.’ The required collateral amount (or margin) depends upon the leverage, type of cryptocurrency, and total value of the position the trader or investor wants to open.
Using the leverage amount and margin, it is quite simple to calculate the collateral that needs to be added to the trading account. To open a position of $1,000 Ethereum with 🗙10 leverage, for instance, the collateral required would be 1/10 of $1,000 = $100. This means that the trader needs to deposit a margin of $100 for the borrowed funds.
It is worth noting that the rise in the leverage amount decreases the required margin – 1/20 leverage for opening the same position worth $1000 drops the collateral to $50. However, higher leverage amounts are accompanied with the danger of higher liquidation.
Apart from depositing the initial margin, the trader needs to maintain a threshold amount of collateral in the account, also known as the maintenance margin. In cases where the tide of the crypto market moves against the trader’s position, the collateral amount might fall below the threshold. This scenario requires the trader to deposit more funds in order to maintain the condition of a marginal threshold so as to avoid liquidation.
Benefits and risks of using leverage in cryptocurrency
One of the major advantages of using leverage is the potential for a quick magnification of trading profits even with a small capital. Another reason for using leverage is that it helps with the liquidation of funds.. This allows traders to use their limited capital for exploring other aspects of crypto like trading, staking, or even investing in cryptocurrencies.
Although the option of higher leverage requiring only a small margin is quite attractive, it increases the possibility of liquidation and decreases the volatility tolerance of funds. If the leverage is too high, even a fluctuation of 1% can result in profound losses.
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