Steemit Crypto Academy Contest / S13W6 - Leverage in cryptocurrencies.

Hello Everyone!
Hope you all are doing well and living a healthy life. This week's topic Leverage in cryptocurrencies of Crypto Academy is very interest to me as I am in trading and used to have leverage positions most of the time.

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In your own words, what do you understand by leverage?

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Literary leverage meaning is — Mechanism to lift something using less power. In financial world, it is used to trade or invest in any asset by using lesser money than its actual investment cost. When a trader come to exchange for trading, exchange provide him a facility of loan. By using that, he can buy or sale more quantity than actually he could do with his own money.

With example, we can understand like I have $100 worth of crypto in my exchange wallet. But I want to trade with more amount. In such case, I exchange gives me loan against my asset. It could be 2:1 to 100:1 depend on the asset. If I take 10:1 means 10 times of my principal amount, I could be able to trade with 10 times of my capital. Why the exchange provide such facility and what are the advantages and disadvantages of leverage? We will discuss later in the article.

Explain how leverage works.

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When any trader takes a leverage position in any trade, the following things happen -

Increases position size

When a trader borrows funds from an exchange, i.e., make a leverage position, his position size increases. e.g., if he is taking 10:1 leverage, his position size will increase 10 times.

Margin requirements/Liquidation

If the market goes in the opposite direction of the initiated trade, exchange will ask more margin to keep alive the trade. There is a certain limit that should be maintained to stay in the position.

If the trader is unable to add margin in time, his position can be liquidated and the trader has to face big loss in the trade.

Huge profit

If market goes in favor of trader, he can make multiple fold profit. A small movement in favorable direction can give higher percentage return on capital used.

Why is leverage used in cryptocurrencies?

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Not only in cryptocurrency but in all market use of leverage has increased a lot. There are some reasons why leverage is used in crypto market.

High liquidity

Crypto market run round the clock 265 days. There should be enough liquidity in the market to run smoothly. Without leverage, it will be difficult for a trader to trade, and they can lose the interest in the market.

Volatility

Crypto is one of the highest volatile market among all. To take the advantage of volatility, trader required large position size. It is the leverage which facilitate any trader to take advantage of volatility in the market by scalping trades.

Diversification

Crypto market is a very vast market. There are more than 10k crypto assets available to trade. A trader can allocate their funds to various assets of choice and with the help of leverage he can trade and take benefit of movement of different cryptocurrencies simultaneously.

If you want to open a long position, and you have 12,000 USDT in Steem and a leverage of 10x. Explain if the price of Steem rises by 45% and then explain if the price drops by 15%. Give your own opinion.

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It can be explained as below.

First Condition
My capital $12000 worth of Steem
Leverage provided 10x, it means I can make a position of $12,000×10=120,000 worth of Steem.
Now if Steem rises 45% then profit will be on $120,000 i.e. $54,000
My return (on my own capital of $12,000) will be huge 450% it means my own capital will grow by 4.5 times.

Second Condition
My capital $12000 worth of Steem
Leverage provided 10x, it means I can make a position of $12,000×10=120,000 worth of Steem.
Now if Steem drops by 15% then the loss will be on 120,000 i.e., $18,000.
Loss on my Capital is $18,000 but, here, my capital was only $12,000. In such a situation when price was going down, exchange will ask more margin and if I am unable to add margin my position will be liquidated. As a result, I will lose my all capital.

Mention the advantages and disadvantages of leverage.

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Advantages

• Leverage allows any trader a big exposure in the market.
• Movement in the direction gives a handsome profit as calculated above in the example of Steem.
• It improves liquidity in the market and allows trader easy entry and exit.
• Trader can allocate his capital to various assets to take advantage of different movement of different assets. I.e., helpful for diversification in exposure.

Disadvantages

• If the market goes opposite to the trader, it could be difficult to handle the situation.
• Trader need to have some margin ready because if trade become unfavorable there are only two options, either book loss or add margin. Even after adding margin, market continuously goes opposite, a big loss can be happened.
• If trader is inexperienced, he maybe liquidated and lose all his capital in short period of time. To manage a leverage position, one must have solid understanding of the market and risk management principles.
• Trade may have to pay interest on borrowed capital.

Conclusion

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Leverage is a double edge sword! It can make any trader rich in a short period of time, on the other hand his capital can be wiped out within a short span of time. Leverage trading required in depth analysis and proper risk and money management, which comes after certain experience.
Hope you have enjoyed reading my post. Please leave your feedback in comments. I invite @ogechukwu-martha, @shiftitamanna and @yakspeace to participate in the contest.