What is leverage in crypto trading?

Leverage in crypto is, in fact, no different from leverage in traditional financial markets. When using leverage, a trader uses borrowed capital to buy and sell cryptocurrencies or other financial assets. By borrowing funds, traders can amplify their buying and selling power to trade with more capital than they would typically have.

How does leverage trading work?

Before you can start leverage trading (also known as margin trading), you’ll need to deposit funds into your margin trading account. The initial capital provided is known as collateral (or initial margin deposit), and the amount required depends on the leverage you want to use. Leverage is commonly denoted by a multiplier, such as 2X (double your collateral), 5X (five times your collateral), or 10X (ten times your collateral). 

Aside from your initial margin deposit, you also must maintain a margin threshold for your trades. Your initial collateral may not be able to cover losses from your positions. In this case, you’ll need to top up your margin account, so it's above the maintenance threshold. If you don’t do this, your positions will be liquidated (closed), and your collateral will be used to pay off any losses.

Leverage is commonly used in spot and futures markets with long and short positions. A long position is where the trader expects an asset's price to go up. In this case, they purchase an asset and sell it in the future (hopefully) for a higher price, or they promise to purchase the asset in the future at a fixed price.

Opening a short position means you expect an asset’s price will fall. Here, you sell an asset and repurchase it (hopefully) at a lower price in the future. You can also enter a futures contract to sell the asset at a certain price in the future, hopefully above the market price at that time.

Using leverage in these cases lets you buy or sell assets based on your collateral and not on your holdings. Even if you don’t own an asset you want to long or short, you can borrow it with leveraged funds.

For traders without access to capital, leverage provides the opportunity to trade with a lower initial investment. It also has the potential to bring higher profits and quickly amplify losses. Leverage combined with market volatility often causes rapid liquidations on highly leveraged positions. 

As always, trade with caution and evaluate the risks before trading with leverage. A responsible trader never invests funds they cannot afford to lose, especially when using leverage.