What Is Leverage in Crypto Trading?

TL;DR

In crypto trading, leverage refers to using borrowed capital to make trades. Leverage trading can amplify your buying or selling power, allowing you to trade larger amounts. So even if your initial capital is small, you can use it as collateral to make leveraged trades. While leveraged trading can multiply your potential profits, it is also subject to high risk - especially in the volatile crypto market. Be careful when using leverage to trade crypto. It may lead to substantial losses if the market moves against your position.

Introduction

Leverage trading can be confusing, especially for beginners. But before experimenting with leverage, it’s crucial to understand what it is and how it works. This article will focus on leverage trading in crypto markets, but a great portion of the information is also valid for traditional markets.

What is leverage in crypto trading?

Leverage refers to using borrowed capital to trade cryptocurrencies or other financial assets. It amplifies your buying or selling power so you can trade with more capital than what you currently have in your wallet. Depending on the crypto exchange you trade on, you could borrow up to 100 times your account balance.

The amount of leverage is described as a ratio, such as 1:5 (5x), 1:10 (10x), or 1:20 (20x). It shows how many times your initial capital is multiplied. For example, imagine that you have $100 in your exchange account but want to open a position worth $1,000 in bitcoin (BTC). With a 10x leverage, your $100 will have the same buying power as $1,000.

You can use leverage to trade different crypto derivatives. The common types of leveraged trading include margin trading, leveraged tokens, and futures contracts.

How does leveraged trading work?

Before you can borrow funds and start trading with leverage, you need to deposit funds into your trading account. The initial capital you provide is what we call the collateral. The collateral required depends on the leverage you use and the total value of the position you want to open (known as margin).

Say you want to invest $1,000 in Ethereum (ETH) with a 10x leverage. The margin required would be 1/10 of $1,000, meaning that you need to have $100 in your account as collateral for the borrowed funds. If you use a 20x leverage, your required margin would be even lower (1/20 of $1,000 = $50). But keep in mind that the higher the leverage, the higher the risks of getting liquidated.

Apart from the initial margin deposit, you’ll also need to maintain a margin threshold for your trades. When the market moves against your position, and the margin gets lower than the maintenance threshold, you will need to put more funds into your account to avoid being liquidated. The threshold is also known as the maintenance margin.

Leverage can be applied to both long and short positions. Opening a long position means that you expect the price of an asset to go up. In contrast, opening a short position means that you believe the price of the asset will fall. While this may sound like regular spot trading, using leverage allows you to buy or sell assets based on your collateral only and not on your holdings. So, even if you don’t have an asset, you can still borrow it and sell (open a short position) if you think the market will go lower.

Example of a leveraged long position

Imagine you want to open a long position of $10,000 worth of BTC with 10x leverage. This means that you will use $1,000 as collateral. If the price of BTC goes up 20%, you will earn a net profit of $2,000 (minus fees), which is much higher than the $200 you would have made if you traded your $1,000 capital without using leverage.

However, if the BTC price drops 20%, your position would be down $2,000. Since your initial capital (collateral) is only $1,000, a 20% drop would cause a liquidation (your balance goes to zero). In fact, you could get liquidated even if the market only drops 10%. The exact liquidation value will depend on the exchange you are using.

To avoid being liquidated, you need to add more funds to your wallet to increase your collateral. In most cases, the exchange will send you a margin call before the liquidation happens (e.g., an email telling you to add more funds).

Example of a leveraged short position

Now, imagine that you want to open a $10,000 short position on BTC with 10x leverage. In this case, you will borrow BTC from someone else and sell it at the current market price. Your collateral is $1,000, but since you are trading on 10x leverage, you are able to sell $10,000 worth of BTC.

Assuming the current BTC price is $40,000, you borrowed 0.25 BTC and sold it. If the BTC price drops 20% (down to $32,000), you can buy back 0.25 BTC with just $8,000. This would give you a net profit of $2,000 (minus fees).

However, if BTC rises 20% to $48,000, you would need an extra $2,000 to buy back the 0.25 BTC. Your position will be liquidated as your account balance only has $1,000. Again, to avoid being liquidated, you need to add more funds to your wallet to increase your collateral before the liquidation price is reached.

Why use leverage to trade crypto?

As mentioned, traders use leverage to increase their position size and potential profits. But as illustrated by the examples above, leveraged trading could also lead to much higher losses.

Another reason for traders to use leverage is to enhance the liquidity of their capital. For instance, instead of holding a 2x leveraged position on a single exchange, they could use 4x leverage to maintain the same position size with lower collateral. This would allow them to use the other portion of their money in another place (e.g., trading another asset, staking, providing liquidity to decentralized exchanges (DEX), investing in NFTs, etc.).

How to manage risks with leveraged trading?

Trading with high leverage might require less capital to start with, but it increases the chances of liquidation. If your leverage is too high, even a 1% price movement could lead to huge losses. The higher the leverage, the smaller your volatility tolerance will be. Using lower leverage gives you more margin of error to trade. This is why Binance and other crypto exchanges have limited the maximum leverage available to new users.

Risk management strategies like stop-loss and take-profit orders help minimize losses in leveraged trading. You can use stop-loss orders to automatically close your position at a specific price, which is very helpful when the market moves against you. Stop-loss orders can protect you from significant losses. Take-profit orders are the opposite; they automatically close when your profits reach a certain value. This allows you to secure your earnings before the market condition turns.

At this point, it should be clear to you that leverage trading is a double-edged sword that can multiply both your gains and losses exponentially. It involves a high level of risks, especially in the volatile cryptocurrency market. At Binance, we encourage you to trade responsibly by taking accountability for your actions. We offer tools like anti-addiction notice and cooling-off period function to help you exercise control over your trades. You should always exercise extreme caution, and don’t forget to DYOR to understand how to use leverage properly and plan your trading strategies.

How to use Margin Trading on Binance?

You can use leverage to trade cryptocurrencies on crypto exchanges like Binance. We’ll show you how to get started on Margin Trading, but the concept of leverage can also be found in other types of trading. Before we start, you’ll need a Margin account. Follow this FAQ article to open it if you haven’t.

1. Go to [Trade] - [Margin] from the top navigation bar.

2. Click on [BTC/USDT] to search for the pair you want to trade. We’re going to use the BNB/USDT pair.

3. You’ll also need to transfer funds to your Margin Wallet. Click [Transfer Collaterals] below the candlestick chart.

4. Select the wallet to transfer funds, the destination margin account, and the coin to transfer. Enter the amount and click [Confirm]. In this example, we’re transferring 100 USDT to the Cross Margin account.

5. Now go to the box on the right. Choose either [Cross 3x] or [Isolated 10x]. Margin in the Cross Margin mode is shared among your Margin accounts, while the margin in the Isolated Margin mode is independent for each trading pair. You can read more on the difference between the two from this FAQ article.

6. Select [Buy] (long) or [Sell] (short) and the order type, such as a market order. Click [Borrow] and you’ll notice that the 100 USDT we transferred to the Cross Margin account is now multiplied 3x to 300 USDT.

7. You can buy BNB with leverage by entering the amount of USDT by [Total], or the amount of BNB to buy by [Amount]. You may also drag the bar below to select the percentage of available balance to use. You’ll then see the amount you’re borrowing for this trade. Click [Margin Buy BNB] to open the position.

Note that you won’t be able to use all of your available balance as you need to pay a trading fee. The system will automatically retain the trading fee amount depending on your VIP level.

Closing thoughts

Leverage allows you to get started easily with a lower initial investment and the potential to bring higher profits. Still, leverage combined with market volatility could cause liquidations to happen quickly, especially if you’re taking 100x leverage to trade. Always trade with caution and evaluate the risks before taking on leveraged trading. You should never trade funds you cannot afford to lose, especially when using leverage.