Crypto Leverage Trading Explained
Leverage crypto trading in is a way of using borrowed funds to trade cryptocurrencies with more capital than initially invested in the trading account.
Trading crypto with leverage increases the buying power for the investor where he or she is able to multiply profits from 2 times up to several hundred times depending on the leverage ratio used.
This is a style of investing where the investor borrows funds from the exchange in return for a fee. When you make a profit, your wins are multiplied by the leverage ratios you use. This also applies to your losses.
What is leverage in crypto trading?
Leveraged trading in crypto can be very profitable once an investor enters the market at the right moment but at the same time, it can be a very risky endeavor as the margin capital put down to trade always acts as risk capital.
In this article, we are going to go in-depth explaining the full definition of leverage in the crypto markets, how it works, when to use it, all the costs, and all other important factors to think about.
How trading crypto with leverage works
Crypto leverage works the same way as it does in other financial markets where you need a broker that offers derivatives trading such as CFD, ETF, Swaps, or Futures. These contracts carry leverage that will increase your position size. The only thing you need in order to access leveraged products is the initial margin deposit which can either be deposited as cryptocurrencies or fiat currency. Once your initial margin is in your account you are free to choose from all the different products that are offered by the operator and open positions your chosen coin.
The added buying power you get on the top crypto leverage trading platform comes from backup funds that the platform owner provides. These funds are not yours to keep and you will only have access to them while you have an active position open in the market. Once the position is closed, the borrowed funds are returned to the broker and the difference in profits and losses are split among you.
What the broker earns is the trading fee which is also increased due to the increased position size, you can read more about fees and commissions further down on this page. When you make a profit with a leveraged position in crypto you either earn profits directly in the coin you are trading, for example, XRP, or you will get rewarded USDT which is a common stable coin that many exchanges pay out profits in.
How to trade crypto with leverage
Opening a trading account and accessing leverage is a piece of cake and almost anyone can do it. Some exchanges will ask for your KYC documents and some won’t, however, I would always recommend trading with a broker that asks for your documentation due to security reasons. Only you can supply the correct KYC documents in case of theft or a hack.
Now, there are several great options for beginner traders to use but no matter which platform you start out with I recommend beginning at lower leverage ratios to learn how the game works. The results from trading with leverage will show effect immediately and the swings in your account might be a little bit shocking as big profits can turn into large losses in a matter of minutes or even seconds. If you are completely new to this style of investing here is a step-by-step checklist you can follow to get started:
- Choose a reputable crypto derivatives exchange.
- Create an account.
- Send in your KYC documents for identification.
- Make your first deposit either in crypto or fiat currency.
- Select the coin and trading pair you want to trade.
- Choose the amount you trade.
- Select the leverage you feel comfortable with.
- Click Buy.
This is a very basic guide to how to get started but it is essentially true for all crypto platforms you will encounter and now it’s time for you to get down to doing some sound research before you increase your size. A great way to make good predictions of the market is to make a technical analysis of the coin you are trading and base your next position on this analysis.
When to use leverage in crypto trading
The best way to use leverage in crypto trading is to use it for added buying power, flexibility, and if you have a small account. Leverage can be a very useful tool to add to your crypto portfolio if you are careful and don’t take on too much risk. Here are the top reasons to use leverage in crypto investing:
- Increase profits
- Trade several markets
- Boost a small account
- Day trading more efficiently
- Use more strategies
- Short-selling crypto with leverage
As crypto investors, we have to fight volatility all the time and it’s usually a problem. But when the markets dry up and price fluctuations are at a minimum, leveraged crypto trading products come in very handy for both traders and investors.
Increase profits – This is the most obvious reason for why do boost your trades with increased purchasing power. After all, adding more capital to your wins will mean a bigger bag of money in the end if you know how to manage the positions in a good way.
Trade several markets – For those of you who are spreading out your risk over several markets know that each position is cut in size and you stand to make less for each market you diversify into. With leverage, you can diversify as much as you like but still keep the same position size in each investment.
Boost a small account – Another great way to use leverage in crypto trading is to boost a small account of $1000 or less. Opening a maximum position of $1000 will yield close to nothing after fees are paid and you need a significant price move to make money. With a 1:10 leverage ratio you can trade positions of $10,000 and now a smaller move of 5% means $500 of pure profit.
Day trading more efficiently – Day traders live and breathe market volatility. But, without proper funding, you should not expect large gains from scalping digital assets. Leverage can improve day trading activities, make them more lucrative, and you don’t have to struggle to make gains if you are good at trading.
Use more strategies – This is one of the most important factors for traders and investors who use leverage. The number of strategies you can run with added capital makes your arsenal of trading opportunities much larger. Instead of trading two or three strategies, you can now shift up to over 10 strategies and even use heading as a tool.
Short-selling – Short-selling is only available through leveraged crypto derivatives and can’t be done on a spot market exchange. When you trade derivatives you have the option to bet on a declining market and profit from falling prices.
Leverage crypto trading risks
There are some not-so-dangerous risks about leverage crypto trading and there are some risks that can end in you losing all your capital, let’s break it down so you can avoid the biggest pitfalls. Below is a list of the most common risks of using leverage while investing in digital assets:
- Difficult to understand
- High fees
- Unexpected losses
- Margin call
If you are aware of these risks and avoid the most important mistakes you are going to have a safer journey to your goals while investing in derivative products or futures markets. To learn more, read our guide on risk management while trading crypto with leverage.
Difficult to understand – The reason why I highlight this as a risk is that many times beginner traders can get caught off guard when they first use borrowed funds to trade with. First of all, you need to be able to calculate your leverage ratios correctly to know how much capital you are using. Second, the platforms that offer this style of investing a usually a little bit more complicated since there is another dimension to the investment process. Make sure you understand what you are doing and how all the moving parts work before you start.
High fees – This is a risk that is not obvious to new investors but it can slowly eat your account and indirectly make you lose money if you are not cautious. Without knowing it, you might be paying $10 or even $50 per opened position if you are using leverage ratios over 1:20. This can pretty quickly result in large losses for active day traders that open 10 – 100 positions per day. Many exchanges also charge an overnight fee if you keep your positions open longer than 24 hours.
Unexpected losses – The crypto market is volatile as it is, but with added buying power the amount you stand to lose and the speed of loss can become almost uncontrolled if you are unlucky. Some positions that start out well can turn sour in an instant and you may lose hundreds of dollars in a matter of seconds if you are not paying attention.
Margin call – A margin call is a risk to your whole account. When you get margin called, your exchange is telling you that your losses have almost grown too big for your account size and if you take on more losses you will lose all your funds or more. This is the warning sign that you have taken on too much leverage for your own good. Scale down and start over.
Liquidation – Liquidation is every crypto investor’s nightmare. Liquidation happens after you get a margin call and you did not act properly. When your losses grow bigger than your margin account balance your exchange will force close all your open positions which will result in a total loss of all your trading capital. You have to pay back leverage in crypto and if you get liquidated all the funds in your account go to pay the loss.
Pros and Cons of Trading Crypto with Leverage
Let’s go through the real benefits and drawbacks of investing in cryptocurrencies with increased buying power, after all, there are two sides to this coin. Depending on how you view the markets and your investment approach you will have different benefits from using leverage. Now, simply listing all the pros and cons without explanation will do not be good, so for each point, I have added a small description to let you know how I see these good and bad aspects.
Multiplied profits – This is the true benefit of a leveraged crypto trading account. The possibility to make 2, 5, or even 10 times more money each time to make a profit is the main reason why traders and investors choose this style of investing. The crypto market is volatile as it is and when you add extra buying power to the mix you can make outstanding gains if you know how to control your risk.
Trade more effectively – This is an aspect that many traders forget as they focus mostly on making money. When it comes to investing money in a good market you want to be able to squeeze the profit of a good setup. The perfect setups don’t come often but when they do you want to maximize the profit by using leverage.
Grow your account faster – One of the biggest struggles of a new trader or even an intermediate-level trader is that they can’t get their account to grow fast enough. I’m not saying that leverage will take you from a $500 account to a $250,000 account in no time but it will enhance the effect of your profitable trades and give you more capital to work with faster.
Trade more coins – This is a given benefit why when using leverage for investing in digital assets. Only by using a ratio of 1:10, you are able to spread your risk and include more coins in your portfolio.
Risk less money per trade – Here is another forgotten benefit of leverage as most investors only see the other side of the trade, the profits. But, when investing with leverage you can reduce your own margin (risk capital) per trade and risk less money per investment. If you keep your ratio between 1:2 to 1:5 you can still have a decent liquidation level from 50% to 20%.
Unlimited losses – This is not a problem with all exchanges and all brokers but some leveraged trading platforms have a risk where you can pretty much lose more than you have and this is a serious issue. Always check with the broker you trade with that they have negative balance protection. What happens when you lose on crypto leverage is a little bit different from forex and stock trading since crypto exchanges normally has built-in negative balance protection.
Go in debt with your broker – Touching on the previous point, you can go in debt with your crypto broker if they don’t have negative balance protection that stops your account balance from going into negative. The worst-case scenario is that you forget to add a protective stop-loss order and your position goes against you during the night and you wake up with a $25,000 debt to your broker.
Underestimate leverage – Most new investors underestimate leverage, especially if the first few trades make a profit. New investors normally add extra leverage to their positions after a few wins discounting the effect of high leverage crypto trading. Switching from a margin ratio of 1:5 to 1:20 has a tremendous effect on your liquidation level and you can get wiped out in a heartbeat if you are not careful. See some of our high leverage trading strategies which can also be applied to cryptocurrency.
Become greedy – This happens to nearly every investor as they try investing with added buying power for the first time. The illusion of making consistent large gains tricks the investor into thinking that this is easy and the over-trading begins.
Overtrade – Once an investor or trader realizes how much money there is to be made with more capital there is a big chance that they fall into overt trading due to the search for quick success. They realize that they are only one or two trades away from a huge win and they chase this profit potential trade after trade without realizing that the increased position size adds a higher fee that quickly eats up the trading capital.
Which investment products offer leverage in crypto
Over the last couple of years, the cryptocurrency leverage trading scene has flourished and several new trading products have appeared. The most popular products are futures contracts and perpetual swaps which are a type of derivatives products. All leveraged products are in one way derivatives because it is a contract that derives their value from something else, for example, Bitcoin.
All crypto derivatives have their prices mirroring another underlying asset, in this case, cryptocurrencies. When you buy, sell, and trade derivatives you are not trading the underlying asset, instead, you buy a contract that reflects the price of that security. This has made it very easy for exchanges and brokers to offer leveraged cryptocurrency products to any investor.
Also, read our guide on why brokers offer leverage to retail traders.
Crypto futures are very similar to normal futures contracts where the buyer and the seller agree on a set price in the future. In the future when the buyer and the seller agree to make the trade, the settlement can be in both physical forms or in a cash settlement. Futures for cryptocurrencies offer very high leverage with ratios up to 1:200 depending on the platform. Futures are used by both retail investors and professional investors as hedging tools when the market volatility increases.
Futures gives the possibility to short-sell the underlying contract which has become much more popular since active retail investors realize that they can either hedge their positions when the market turns sour or profit from a naked short position. Futures are seen as high-risk investment vehicles and should be fully understood before attempting.
Cryptocurrency derivatives are a name for most leverage-bearing contracts such as futures, swaps, and other leveraged tokens. Derivatives mirror the price of the underlying contract and do not offer trading directly with the targeted security. For example, if you buy a derivatives contract of Ethereum you will not directly own Ethereum, instead, you own the derivatives contract of Ethereum.
Derivatives contracts have made it very easy for brokers and exchange operators to provide leverage for their customers since there is no need to code a platform that is hosted on the blockchain where all digital assets are transacted. Having a leveraged platform on the blockchain would require a lot of work and we have not come that far yet in technological advancement. Overall, most derivatives are considered high-risk since they offer very high leverage for cryptocurrencies.
Perpetual swaps are a kind of leveraged contract for cryptocurrency where the swap between a buyer and seller is agreed upon. Perpetual swaps are very similar to futures contracts with the one difference being that they don’t have an expiration date in the future. You can keep a perpetual swap contract open for as long as you want and there is no physical settlement.
Most new cryptocurrency exchanges with leveraged trading platforms offer perpetual swaps. This type of investment vehicle is considered a high-risk investment as most platforms that offer this kind of contract is not regulated. Perpetual swaps have had their fees reduced due to the surge of demand and are quite cheap to trade with.
CFD stands for contract for difference and is a very old type of product for leveraged contracts. Most forex brokers are CFD brokers and they have very established platforms where most of them are regulated by a local government. Some of the more famous CFD brokers that offer crypto trading are Avatrade, Plus500, and AXI.
CFD leverage trading is considered very high-risk as the platforms offer the highest leverage ratios in the world for cryptocurrencies. It is possible to access margin ratios of 1:5000 or more by using an offshore CFD broker. The big benefit of using a CFD broker is that the fees are among the lowest in the industry but take care when signing up for unreputable and make sure they are regulated in their jurisdiction.
Options are more complex cryptocurrency trading instruments where a buyer and a seller agree upon a fixed price and date in the future. The buyer pays a premium which is the maximum risk of the transaction. Cryptocurrency options are a type of derivatives contract that offers a fixed risk investment and are seen as a medium-risk investment due to how the fixed risk works but if you are a seller of an option contract you have accepted an unlimited risk ratio.
Crypto options are becoming more of a household name in the industry but they are yet too difficult for retail investors and they are mostly used by experienced traders who are looking for a certain crypto leverage trading strategy or diversification to their portfolio. Some of the more advanced crypto exchanges that offer options are Binance, OKX, and Gate.io.
Leveraged tokens are very similar to ETFs but with an added leverage ratio of 1:2, 1:3, or 1:5 to a standard ETF contract where the buyer benefits from borrowed funds when purchasing the contract. These tokens are a type of derivatives contract where the price is derived from an underlying asset, for example, Bitcoin or Ethereum. They are seen as medium-risk investments and are a decent investment vehicle for both beginner investors and experienced investors.
What makes these leveraged tokens good for beginners is the ease of use and the relatively low margin requirements and leverage ratio added. However, keep in mind that most exchanges add a management fee or a rollover fee that is charged every 24h when the contract is kept open. This is an interest payment for using the borrowed funds. This fee tends to be low around 0.03%.
ETF stands for Exchange Traded Funds and is an electronic type fund and derivative contract that invests in specific asset classes including cryptocurrencies. When you purchase an ETF you buy a contract that derives its price from another underlying security. ETFs are mostly used by long-term investors as they are more of a buy-and-hold instrument. ETFs can be leverage-bearing but the ratio is usually less than 1:10.
Some ETFs offer short-selling as a hedge against market fluctuations where the investor can buy a short ETF to bet on a declining market. Some of the more popular exchanges have started to include ETFs as they have grown popular in traditional finance and they are a cheap and easy way to access exotic assets such as cryptocurrencies.
Crypto leverage ratios explained
Crypto leverage ratios are best understood if you think about a position in two pieces, your part, and the borrowed funds that your cryptocurrency exchange provides.
Your part is the margin capital you add to open the position and the rest is the full leverage ratio of the position.
For example, if you open a position with 1:2 leverage you will open a position that is two times bigger than your current account balance. In this case, you will pay 50% of the full position. Should you increase the leverage ratios to 1:4, which means that you are opening a position four times bigger than your account size, then your own margin ratio will be 25% of the full position size.
The calculation of leverage ratios in cryptocurrency goes on like this and to explain things further I’ve included a table below with the most common ratios of both margin and leverage. Check the table to see how much of your own capital you need to add for each leverage ratio.
The total margin capital for each leverage ratio that you have to add to the total position size is written in cursive script.
|Leverage ratio (Margin ratio)||1:2 (50%)||1:4 (25%)||1:10 (10%)||1:20 (5%)||1:50 (2%)||1:100 (1%)|
|Total position size|
As the ratios become higher the margin requirements shrink and if you trade crypto with a 1:100 ratio you can open a position of $10,000 with only $100. Keep in mind that this is not a recommendation as investing with a 1:100 leverage ratio gives you a 1% liquidation level. This means that if you open a position with a 1:100 ratio you can only afford a negative movement of 0.99% before you are completely wiped out.
Read our educative guide on the best leverage ratio for crypto beginners to learn more on this topic.
Also, see our guide on best leverage for small accounts.
Fees & Commissions
How does leverage change the fees when trading cryptocurrencies? This common is very common so let’s answer it once and for all. First of all, each crypto exchange has its basic fee, for example, 0.25%. When it comes to leveraged products the fees are generally reduced to compensate for the bigger position sizes that often are opened by investors. When you open a position with a 0.25% fee the calculation is simple. Let’s say that you have $1000 in your investment account and you open a position for the whole $1000. This is the calculation:
$1000 x 0.0030 = $3
In this example, you will pay $3 in fees for opening the position. But what happens when you add leverage to this equation? Well, we are going to use the same fee of 0.30% and make another calculation with the same investment account of $1000 but now based on a position that has a leverage ratio of 1:20. The position will be a maximized position of the full account size of $1000 + the 1:20 ratio.
Use our crypto position size calculator or calculate the position size manually:
$1000 x 20 = $20,000
Now, let’s calculate the trading fee for the new position size of $20,000 with the same fee of 0.30%.
$20,000 x 0.0030 = $60
You will pay a $60 fee for opening a $20,000 position size. This is much more than the previous $3 you paid for not using only your money. This is how you calculate your fee when trading cryptocurrencies with added buying power and it all depends on how big your position size is. Once you know your full position size, which can be calculated by using the leverage ratios above, you can then easily calculate the full fee of your position. Below is a simplified calculation that will help you calculate on your own.
Position size x Trading fee = Total fee
Now, leverage doesn’t change the fee of the position, it is the total size of the position that determines the fee you pay and leverage increases the overall fees because traders and investors tend to maximize their accounts to open the biggest position possible and therefore paying a higher fee to their exchange.
How to calculate leverage in crypto trading?
There are two things that you will find out by calculating your leverage when trading cryptocurrencies. First, your margin requirement, or how much of your own capital you need to put down to open a position. Second, your maximum position size.
These are the two essential leverage calculations that every investor needs to know before getting started. Today, you will learn the simple ways to do this calculation in no time so that you can quickly figure out how much money you need for each position and how big the position size will be for each leverage ratio.
I will use two tables to describe these calculations. The first table will be on how to calculate the margin requirement for your position and the second one will be to calculate the maximum position size depending on your ratio and your current account balance (margin capital).
This table will help you calculate how much of your own account balance (margin capital) you need to put down to open the position size to the left using different leverage ratios from 1:2 to 1:125. Your required margin capital is written in cursive script. To make your own calculation, follow this example:
Position size / Leverage ratio = Margin requirement
When you look at this table it’s obvious what kind of effect leverage has on the calculation of your margin capital. When opening a position size of $75,000 with a leverage ratio of 1:125 you only need $600, but to open the same position of $75,000 with a leverage ratio of 1:5 you need to add $15,000 from your own account balance.
In this next table, you will see how we calculate the different position sizes depending on the account size (margin balance) from $200 to $12,500 with different leverage ratios from 1:2 up to 1:125. This is an example where we assume that you are going to maximize the account size and use all your margin balance in each position. To make your own calculation, follow this example:
Account size x Leverage ratio = Maximum position size
|Account size (margin balance)|
This table shows the true power of leverage. To be able to open a position of $25,000 with only $200 in your account gives you plenty of buying power and with an account size of $12,000 you can open a position size of $1,500,000 if you use 1:125 leverage. Keep in mind that these levels of leverage are very difficult to trade with and very risky. The reason why the risk is so high is that your liquidation level shrinks to less than 1% when using ratios over 1:100.
Where to trade crypto with leverage
The most common way to access leveraged crypto products is through crypto derivatives exchanges, however, there are other options such as CFD brokers, options platforms, and dedicated futures trading platforms. Derivatives exchanges offer derivatives contracts that are very easy to deal with and they provide an easy route for the exchange to deliver cheap products to its customers. Derivatives exchange are generally pretty cheap to trade on and have therefore risen in popularity.
It’s important to know what platform you are signing up with as many leveraged platforms are in the game to earn a quick buck without providing good service. The best reputable platforms are always regulated by their local government and if you are going for security I highly recommend trading on a regulated platform. Regulated crypto exchanges that offer high leverage are still few but there are some good exchanges such as BitYard and BitMart.
Recommended article: What is high leverage trading?
Crypto derivatives exchanges
Derivatives exchanges are relatively new and have gotten very popular due to their ease of use, low transaction fees, and robust trading interfaces. They are the new era of trading where digital assets thrive and amount in the masses. The most popular contracts offered on these exchanges are:
- Perpetual swaps
- Inverse perpetual swaps
- Leveraged tokens
When trading on a derivatives exchange you are not trading the underlying asset, instead, you trade a contract that derives its value from another asset such as a currency, commodity, and in this case cryptocurrencies. Crypto derivatives exchanges offer staggering levels of leverage and can be very risky trading vehicles if you are now into crypto investing. What makes them so attractive is that they can host a lot of different contracts at very low fees.
Derivatives exchanges do not have to be regulated to operate and depending on what jurisdiction they operate there are different rules on how what contracts they can promote. It’s very common for a derivative exchange to list up to hundreds of different altcoins to attract as many traders as possible. In one way it’s a win-win because they offer good leverage trading in almost all crypto coins for a reasonable price. It’s important to know that trading in derivatives products always has their settlements in cryptocurrencies and all the gains and losses that incur in your account are paid for in crypto.
CFD stands for Contracts for difference and they are quite similar to derivatives contracts where they mirror the price of an underlying asset. When you purchase a CFD contract you do not get ownership of the underlying asset, in this case, Bitcoin or any other cryptocurrency. Not even when you profit from a Bitcoin contract will you get paid in cryptocurrencies which is one of the disadvantages of using a CFD broker.
Most reputable CFD brokers are regulated by their local government and if you encounter a CFD broker without regulation or license to operate as a money service business you should watch out. Some of the more commonly recognized CFD brokers are AvaTrade, CMCmarkets, and Naga. All of these platforms are regulated in their own jurisdiction.
What makes CFD brokers so popular is that they offer extremely low trading fees, very high security, great educational material for new investors, and overall a superb trading experience. Since CFD brokers started out as forex trading platforms and grew in size quickly, this has made them wealthy enough to add plenty more features than other crypto exchanges. You could say that trading on a CFD broker is like driving a BMW compared to some derivatives exchanges that are the equivalent of Volkswagen.
Is it legal?
The legality of cryptocurrency trading is in debate as we speak. So far, the United Kingdom has banned all leveraged cryptocurrency trading through CFD brokers. This has not stopped traders from the UK to access leverage for cryptocurrencies as there are plenty of off-shore options to choose from.
The US offers great products where investors can access leveraged crypto trading products but it seems that most of these platforms are required to get a license to operate in most states. Something that we’ve seen is that products that are launched in the US have higher scrutiny.
In Europe, the view of cryptocurrency leverage trading is very different. Malta, a member of the European Union has opened the doors to several crypto platforms such as Binance and OKX where crypto traders can access high leverage ratios for digital assets.
Australia seems to have legalized leveraged products but they keep the ratios controlled and no more than a ratio of 1:2 is available. These might seem like low levels to most people but that is because the Australian people have been outright wiped out by uncontrolled crypto trading with borrowed funds.
What other traders ask
It’s a type of investing where you use borrowed funds from your trading platform to access more capital and open bigger positions.
If you are a beginner trader and want to try it out I recommend that you start with low ratios of 1:2 or a maximum of 1:5.
The same thing happens to a leveraged position when you lose money. The only difference is that your maximum position is bigger and your losses might be bigger.
5x leverage means that you are borrowing five times the money in your trading account from your broker. If you currently have $1000 in your account, 5x leverage would give you access to trade with $5000.
For experienced traders that have a strict routine and strategies, it can be a very good addition to your wins where the added buying power will increase your profits.