Steemit Crypto Academy Contest / S13W6 - Leverage in Cryptocurrencies

Assalamualaikum everyone!

Welcome to the post. Hopefully, all of you will be doing well and enjoying the time with the grace and blessings of Almighty Allah. Today, I'm here to be a part of the week 6 contest in the beloved SteemitCryptoAcademy. The topic of discussion for this week is very much important, Leverages in Cryptocurrencies. So, let's start the fun without any wastage of time.

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

The term leverage is a widely used term in the financial markets. Using borrowed funds or capital to increase the returns on trade or deal is known as leverage. It is an effective strategy that may be used to increase earnings as well as losses. Leverage can be a useful tool for organizations and investors to reach their goals more quickly and effectively. On the other hand, improper use of leverage can result in large losses as well.

The same is the case in the cryptocurrency world as well. Leverage refers to the process of using borrowed funds to increase the possible gains from crypto trading. This allows traders to open greater positions than they would with their own money, potentially leading to significant gains. Similarly, the chances of loss from the trades also increases as we know that the high volatility is always present there.

Usually, leveraged cryptocurrency trading is actually the process of taking out a loan from a cryptocurrency exchange or a broker. In order to guarantee the loan, the exchange will ask traders to post a specified amount of collateral, or also called margin. The amount of borrowed money in relation to the trader's margin is determined by the leverage ratio. If a trader had a 10x leverage ratio, for example, they could borrow ten times their margin.

Let's say, a trader has $100 and thinks Bitcoin (BTC) will increase in value. They choose to borrow $400 from the exchange in order to apply 5x leverage, increasing their total trading capital to $500. A 10% increase in Bitcoin's price may result in a $50 profit for the trader, or a 50% return on their original $100 investment. So, in this way the leverages increase the potential gains.

It is also important to note that Leverage can increase profits, but it can also increase losses. The trader will lose a lot more money than they would have if they hadn't employed leverage if the price of crypto coin move against their position.

Leveraged traders may experience margin calls in severe circumstances as well, which would need them to deposit more money in order to keep their positions open. They could lose a lot of money if their positions are liquidated if they don't meet the margin call as their margin accounts are completed liquidated. So, its's highly risky as well.

Explain how leverage works.

As we have already discussed that the use of borrowed money to increase the prospective returns on an investment is known as leverage. It is a potent instrument for increasing both earnings and losses as well. When leverage is used correctly, it can assist investors and traders in achieving their goals more quickly and efficiently. When leverage is employed incorrectly, however, it can result in huge losses as well.

Let's move towards the working of the leverage and some of the important terms that are related to the concept of the leverage in cryptocurrencies,

Leverage is used to invest in an asset by borrowing money from a broker or exchange. The amount borrowed is added in the original margin of the traders. The investor then uses the borrowed funds to purchase more of the asset than they could with their own funds alone.

The leverage ratio is calculated by dividing the amount borrowed by the amount of the investor's own money. For instance, if an investor use $1,000 to purchase $10,000 in crypto, the leverage ratio is 10:1. This indicates that the investor controls $10 worth of asset for every $1 of their own money.

Moving towards an Example...

Suppose an investor has $100 and feels the price of a particular cryptocurrency will rise. He choose 5x leverage, which means borrowing $400 from the exchange to increase their total trading capital to $500. If the crypto price rises by 10%, the trader will make a profit of $50, indicating a 50% return on their initial $100 investment.

Now, what is Margin Call or Liquidation..?

It is also important to be aware of margin calls and liquidations when employing leverage. When the value of an investor's investment falls below a specific level, a margin call happens. The investor will subsequently be required to deposit more funds to meet the margin demand by the broker or the exchange on which he is trading with leverage.

If the investor fails to fulfill the margin call, their positions may be liquidated, which means that the assets may be sold or the all positions are closed at the same time to repay the loan that the investor has taken from the exchange in the form of the leverages. In this way, the traders have to face a lot of loss as well.

Why is leverage used in cryptocurrencies?

As we all know that the market of the cryptocurrencies is very much volatile. We have discussed the facts about the leverages in the above sections. Now, we will discuss the main reasons behind the use of the leverages in crypto space.

The first and the most important thing is that the leverage allows traders to multiply the possible rewards on their cryptocurrency investments. Traders can control a larger position with borrowed funds than they could with their own resources, potentially results in huge gains if the crypto price moves in their favor.

Another important use case is that the leverage has the potential to increase trading volume in cryptocurrency marketplaces. Leveraged traders can open larger positions, resulting in increased liquidity and more frequent price changes. Both traders and market makers might gain from this.

In speculative trading like the crypto trading, the traders predict the market direction of cryptocurrency prices without completing extensive study or analysis. This can result in volatile market circumstances and higher trading risks.

Because of the fact that the leverage allows for short selling, traders can profit from a cryptocurrency's price decrease. Traders can borrow a particular crypto asset and then sell it at the current market price and repurchase it at a cheaper price, making profit from the difference.

Last but not least, leverage is frequently utilized in more advanced trading strategies, such as arbitrages and high-frequency trading. Profits can be generated by leveraging slight price variations between different crypto exchanges or by executing trades fast.

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.

The Initial Investment Is:

• Steem Holding: 12,000 USDT
• 10x leverage
• Total investment: 12,000 USDT * 10 = 120,000 USDT

• Steem's price has risen by 45%.

It means,

• 12,000 USDT * (1 + 45%) = 17,400 USDT is New Steem Holding

• Steem Holdings Total Value: 17,400 USDT * 10 = 174,000 USDT

Profit From a 45% increase:

• Profit = total value after price increase - total investment

• Profit = 174,000 USDT - 120,000 USDT = 54,000 USDT

• Steem price decrease: 15%

It Means,

• New Steem Holding Value: 17,400 USDT * (1 - 15%) = 14,730 USDT.

• Steem holdings total: 14,730 USDT * 10 = 147,300 USDT

Loss From a 15% increase:

• Loss = total value before price drop - total value after price drop

• Loss = 174,000 USDT - 147,300 USDT = 26,700 USDT

Moving Towards Overall Profit...

Overall Profit = total profit gained - total loss

Overall Profit = 54,000 - 26,700

Overall Profit = 27,300 USDT

In my opinions, Leverage has the potential to increase both gains and losses. In this scenario, the initial 45% increase in the price of Steem resulted in a considerable profit of 54,000 USDT. The subsequent 15% drop in price, however, lowered the overall profit to 27,300 USDT. This shows the significance of risk management while employing leverage, as losses can quickly increase if price fluctuations are very high.

Mention the advantages and disadvantages of leverage.

As we all know that nothing is prefect in this universe. The thing which has some benefits, also have some drawbacks on the other side. So, let's discuss some of the advantages and disadvantages of using leverages in the crypto space.

Advantages of Using Leverages:

• By using leverages, the traders can increase their profits by borrowing funds from the exchanges and hence increasing the value of their positions.

• Another advantage of using leverage is that the Leverage can enhance market trading volume. Leveraged traders can open larger positions, resulting in increased liquidity and more frequent price changes in the market.

• Moreover, it increases fluctuations in the market of the particular cryptocurrency and hence increase the opportunities for Speculative Trading.

• The leverage trading also increase the opportunities for short selling as the traders can buy the same asset at the lower price and make good returns from the market differences.

• Another important advantage of the leverages is that the advanced trading strategies like arbitrages and frequency trading can be done efficiently and effectively.

Disadvantages of Using Leverages:

• Just like we have discussed that the leverage increase the profit ratio. Similarly, it also increases the loss ratio as the positions are huge.

• Another thing is that the Margin Calls can make the traders very much worried about their investments and hence they are very risky.

• The account liquidation has always been a huge risk for the traders who are new to the leverage trading. So, it is also another disadvantage.

• Another important thing to notice here is that the leverages can also reduce the financial stability of a trader as the market moves against his prediction, it is difficult for him to repay the loan.

• Complexity of the leverage trading has always been a major issue that most of the traders face and hence many of the traders are afraid about leverage trading.

Conclusions

Leverage is a tool that may be used to increase both potential gains and losses. It works by borrowing money from a broker or exchange in order to invest in an asset. The amount borrowed is known as margin, and the leverage ratio is the ratio of borrowed money to the investor's own money. Leverage can be utilized for a variety of reasons, such as raising trading volume, increasing potential returns, speculative trading, short selling opportunities, and many more.

I would like to invite my friends @artist111, @suboohi, @ripon0630 and @fantvwiki to be a part of this amazing contest.