Cryptocurrency trading with leverage: a guide to using leverage correctly

Leverage is an important consideration when thinking about where to open a position or whether to go long or short. A brief definition of leverage is that it allows you to increase your total trading capital by using both your own capital as well as additional funds offered to you by a lender. This means that you will be able to open a trade for substantially more than what you could actually afford to lose.

For example, if you are using a 10X leveraged account, you will control a position that is 10 times larger than the value of your initial deposit but your profit and loss will be based on the entire value of the position, not just your deposit. You would only lose the amount that you deposited (this is referred to as margin) plus any interest you may owe to the lender (i.e., the borrowing rate).

To better help you understand how to use leverage properly, here are a few terms that you will likely encounter in the world of crypto trading:

• Margin: This is the amount of collateral that you must put up to open a position. There are two types of margin: initial margin (the margins you must put up when you first open a position) and maintenance margin (the minimum value you must maintain to stay in the trade).
• Liquidation: This is the automatic closure of your position by the exchange when your losses exceed your margin; thus, you cannot incur any further debt above the value of your margin.
• Leverage: This is the ratio of the value of a position you control versus the value of your margin.

It may seem like a simple concept, and it can be, however, in the world of crypto a lot of caution should be used as the risks associated with leverage in the world of crypto are extreme. I will further explain how leverage acts as both a benefit and a detriment to the investor below.

Trading on Margin in Historical Context & Trade Issues

The origins of trading on margin date back over a hundred years to when it was first introduced into trading on the stock exchanges. Using leverage trading almost always resulted in speculation; one of the famous events we saw at that time was the stock market crash of 1929.

Today, we see very strict limits placed on leverage by regulators in traditional financial markets. For example, the US usually has a maximum of 2:1 leverage on stocks. The opposite is true for cryptocurrencies. Many of the primary exchanges currently offer you up to 125x of leverage for margin accounts. This may appear attractive, however, this type of borrowing also exposes you to a significant risk, and it can be very costly if something goes wrong.

While leveraged trading on margin is a standard practice among many traders in the crypto-markets today, there have also been many widespread liquidations due to large price volatility. An example of this is that over 78% of all margin trades in crypto were liquidated at a loss in 2024. In addition to this, many Decentralized Finance (DeFi) platforms provide their own version of trading on margin, which would increase the number of participants in margin trading, but would significantly increase the risks involved.

Margin Trading in Cryptocurrency — How Margin Trading Works

The most commonly used method of trading on margin is a simple process however you need to ensure that you work correctly and apply an appropriate level of attention to detail. Here are the normal steps involved in performing a trade on margin:

1. Select your level of leverage (for example: (5x and 10x) depending on how much you want to trade).
2. Fund your margin account with your collateral to cover your initial margin for the trade (whichever amount you select as your level of leverage).
3. You will be loaned the balance of your trade by the exchange up to the total value of your trade.
4. Once the trade is executed; you have either bought or sold the asset at the full value of your order.
5. Stay aware of your margin level so you do not become liquidated.

When you close your position, the exchange will return you any excess amount of money that you did not use to open the trade and thus "lock in" any gains or losses that you may have incurred as a result of opening that trade.

For example, if you had a trading margin of $1000, and you opened a $10,000 position using 10x leverage, your risk of losing your entire deposit would be 10% of your total position. If this price drop occurred then your position would close automatically or through your stop-loss order.

Two Examples of Using Leverage

1) Example of a Long Trade

A trader buys a long position of $30,000 worth of Ethereum at 5x leverage (by contributing $6,000 of their personal money). Should the price of Ethereum increase from $3,000 to $3,300 prior to them closing their position, their profit will be $3,000, which is equivalent to 50% return of the invested margin. Therefore, this is why we see a lot of traders using leverage during periods of growth.

2) Example of a Short Trade

Alternatively, imagine a trader borrows 0.25 BTC from an exchange to sell it at $10,000, using 10x leverage, with an expectation that the price will fall from $100 to $80 per BTC. In this case, they would receive a profit of $2,000, which represents a 200% return of the investment ($1,000). Pretty tempting; don't you think?

But remember: risks will always equal profits. A small price movement against you can quickly erase your deposit.

The Influence of Leverage on Profit and Loss

(This example assumes that it has been calculated at 10x leverage.)

This may look impressive to some traders, but unfortunately, the statistics surrounding leverage trading indicate that over the course of 2024, 78% of all leverage trades ended in a loss.

Understanding Leverage

The Size of Leverage Based on Type of Trader

If you are a new trader, it is advisable to begin with low risk (2x–3x), therefore, you should consider trading BTC or ETH (which are two of the easiest trading currencies to follow). With a higher level of volatility associated with altcoins, combined with a high level of leverage, you can have a completely cleared out account before the end of the day.

Understanding Collateral and Margin Requirements

Initial margin is defined as the position size divided by the leverage value: Initial Margin = (Position Size) / (Leverage). Maintenance margin is the minimum dollar amount you must have in your account to keep your positions open or your entire position may be liquidated by pushing your account below a designated margin rate. In general, that amount is anywhere between .5% and 2% of your total account value.

There are two primary margins offered by an exchange:

• Isolated Margin: Limits Risk to only the amount you assign to that position.
• Cross Margin: Your risk covers your entire account balance and, should any of your positions get liquidated to cover one of your other open positions.

For instance, this type of risk is demonstrated by the number of liquidations issued by Falcon Finance on October 23, 2024 due to a very steep price drop resulting in almost 47 Million USD in liquidations simultaneously.

Position Liquidation: Definition and Description

Liquidation occurs when your margin is wiped out resulting in an automatic closing of your position by the exchange. The result will be the lost deposit and, in some cases, some liquidation cost.

To prevent liquidation, I advise you to:

• Put a stop-loss at about -3% – -5% of your total account balance.
• Don't risk everything you have leaving yourself a certain amount of money to use—leave yourself a buffer of free cash (30–50%).
• Check and track your Margin Level continually, many exchanges and ASCN.AI provide alerts or real-time margin information.
• To minimize risk from any one position by using an isolated margin.

ASCN.AI has a great liquidation calculator and notification system that has saved hundreds of individuals from blowing out their entire account through highly volatile market conditions.

Risks and Risk Management with Leverage

Main Risks of Leverage

You can lose all of your personal investments in a matter of minutes. The price could go against you and you would have nothing to show for it.

Cascade Liquidations: Close positions at mass levels will further decrease the market pricing.

Fees & funding: You will lose profits as funds cost you money to hold each night and if you trade with leverage, these will accrue relatively quickly. These fees could be anywhere up to 0.30% per day, which is almost 9% monthly.

Psychological pressure: Stress, trying to recover a loss, having too much joy, or being in panic can drive individuals to make errors when trading in leverage. Kaiko Research (2023) has concluded individuals trading using too much leverage have a 3.4 times greater overall chance of losing their investments because of emotional reactions.

Market manipulation: Major participants can create a volatility in the Liquidation market by forcing traders out of positions, while profiting from market shifts.

Ways to Minimize Losses

• Use stop-losses.
• Do not put at risk any more than 1% – 2% of your complete budget on any one trade.
• Disperse your money among multiple assets to reduce your risk associated with any specific investment or asset class.
• Pay attention to on-chain metrics to understand what the large traders in the market are doing, which will help you better understand what is going on in the markets.
• If you have been using isolated margin, then you are likely to avoid large losses, even with a margin account.
• By maintaining a journal of your trades, you can use your mistakes to improve your future trading process.

Best Practices for Beginners

• Do not use more than 3x leverage until you have enough experience and are comfortable.
• Trade liquid trading pairs such as BTC and ETH.
• Do not risk your entire deposit on one trade; always have a cushion for yourself.
• Understand the liquidation process and use risk calculators to your advantage when trading.
• To start using leverage, make your trades in very small increments until you feel comfortable trading larger amounts.
• Use leverage automation and monitoring options offered through (ASCN.AI).

Conclusion: Leverage in Crypto Trading

The primary reason that traders choose to utilize leverage is that they can profit much greater from price increases than they would be if they were not using leverage. Traders can utilize leverage to increase their trading volume significantly relative to what they have available to invest. Additionally, traders can utilize leverage as a hedge against adverse price movements and take advantage of any arbitrage opportunity in the market.

Some common pitfalls associated with leverage include:

• It is possible for you to lose your entire deposit in a matter of minutes.
• You can incur significant amounts of trading costs and/or funding costs that will reduce your overall profits.
• You will find that you experience a lot of emotional stress from making mistakes when the pressure is at its highest level.
• Because of mass liquidations, the potential for market manipulation is increased as well.

Using leverage can be a viable option for traders who understand the risks involved in using leverage and know how to effectively manage their risk, use effective risk management tools, and continually improve their knowledge of crypto trading using the most recent trading/software technology such as ASCN.AI. Beginner traders should be conservative, by keeping their leverage low, and focusing on spot trading using small amounts of leverage until they gain experience and/or create a strategy allowing them to avoid using their entire deposit to create their trading career. In addition, beginner traders must focus to keep their mind sharp so they are able to preserve their capital.

Frequently Asked Questions

How is leverage different from regular crypto trading?

Regular spot trading means you will only utilize your own money for your purchase and regardless of any market fluctuations, you will only either have a capital loss or gain if the market price of the security has moved is either higher or lower than your purchase price. In addition to having your capital at your disposal through regular spot trading, the leverage you use is only relative to the capital you originally invested. Thus the profits and/or losses you achieve with leverage are greater than your regular capital investment amount, any loss on your leverage that makes your capital too small to cover can potentially cause the position to automatically liquidate and may cause you to lose your collateral.

What cryptocurrency trading platforms allow access to leverage?

What are the fees incurred with the use of leverage?

• Funding: Up to 0.3% per day; charged depending on whether shorts or long are involved.
• Borrowing Rates: Typically between 0% – 37% approx. per annum depending on what day you take the position.
• Liquidity Fee: Typically between 0.5% – 1.0% of the total position of position size at the time of liquidation.
• Slippage: This refers to the difference between the closing and expected closing of the position.

Can I trade without using leverage?

Yes, using spot trading you purchase cryptocurrencies with your cash and there will be no way to have your position auto-liquidated via spot trading. Using DCA through holding long-term purchases, Arbitrage trading, and stake trading; are other ways in which you will not face liquidated position.

How will I determine which leverage size is suitable for me?

• Evaluate both the level of experience and your risk tolerance.
• Analyze the volatility of the asset.
• Risk no more than 1% – 2% of the total trading size and/or your overall capital on a trade.
• Test the leverage concept by using the leverage with much smaller amounts to develop enough experience to utilize greater amounts.
• Complete a risk analysis using the risk calculator as defined by ASCN.AI.