Leverage Meaning
What is Leverage Trading in Crypto?
Leverage is used in a variety of contexts, including business, personal finance, investing, and cryptocurrency trading. In business, it is used to assess an organization’s financial position, including financing operations, projects, and purchasing assets.
Assume you’re running a small business and you intend to make more profit for expansion. Rather than selling your company shares, you approach a broker for a debt to raise money to finance large purchases. The borrowed money will increase your company’s potential for profits. However, it will also increase the economic burden if you instead experience losses and fail to repay the debt. By borrowing funds from the broker to boost your purchasing power, you have used leverage.
In the context of crypto, leverage trading describes using borrowed capital or debt as collateral to make trades or gain greater exposure to a position. When individuals use leverage in crypto, they are essentially borrowing money from a broker to purchase more crypto than they could afford with their own capital. If the cryptocurrency’s value appreciates, it will make a profit on the original investment plus the borrowed funds. However, if the price of the cryptocurrency goes down, you will lose money on both your original investment and the borrowed funds.
Investors and traders utilize leverage to engage in trading different types of crypto derivatives, such as margin trading and futures contracts.
How Does It Work?
Leverage trading requires that individuals have a certain amount of capital, called margin, that acts as collateral to the borrowed funds. The leverage is expressed as a ratio of the margin to the potential loan amount. An investor utilizing a 1:50 leverage, commonly expressed as 50X, will purchase a cryptocurrency worth 50 times their initial investment. This means that if they have $100 in their account, they can make a trade worth $5000.
If traders using leverage incur losses, they inject more crypto into their accounts to maintain a margin threshold. Otherwise, they risk liquidation if the margin falls below the threshold. Traders use it to open a long position if they believe the crypto asset will go up, and a short position if they expect the asset’s price to go down.