Cryptocurrency derivatives and investment products have become popular options for many people’s daily investments. However, the complex user interfaces and various investment jargon of exchanges often leave beginners feeling overwhelmed before they even take their first step.
In light of this, “WEB3+” has launched a series of reports called “Cryptocurrency Investment in Plain Language,” aiming to introduce the most accurate concepts of cryptocurrency investment, as well as the underlying logic, innovation, and latest trends.
What is leverage?
“Leveraged trading” is a trading method that exists in both traditional finance and cryptocurrency investment. However, even in traditional financial markets, leverage trading is not something beginners would typically encounter. It is considered more of a “professional-level” investment, so most beginners have only a vague understanding of the concept and principles behind leverage trading.
Leverage trading, also known as margin trading, is a classic financial trading product in the traditional finance field. The principle of leverage trading is to amplify the trading amount that can be invested by borrowing funds, allowing the trading position (also known as a position, referring to funds commonly used in financial, securities, stocks, and futures trading) to exceed the amount in the trading account.
Gracy Chen, General Manager of Bitget, gave an example to illustrate this. Suppose a user is bearish on a particular cryptocurrency and believes it may decline in the future. In that case, the user can go short (short sell) it.
Short Selling:
A trading strategy that involves selling financial assets first when they are expected to decline in the future, then buying them back after the decline to profit from the price difference.
So, the user invests $3,000 in this operation. However, if the user adds “3x leverage” at this time, it means the user has “borrowed $2,000” and added it to the initial investment of $1,000, resulting in a total investment of $3,000. In simple terms, the capital has tripled from $1,000 to $3,000, hence the term “3x leverage.”
Suppose this cryptocurrency drops by 50%, from $1 to $0.50. The user was originally making a 50% profit, but because of the 3x leverage, the money earned will be 50% multiplied by three, resulting in a 1.5x profit. This is an example of a leveraged trading short position. Of course, leveraged trading can also be used for long positions.
Gracy also pointed out that Bitget also provides services for “long trading” and “short trading,” allowing users to borrow tokens to go short and then exchange them back through trading.
Gracy continued with an example: Suppose today the user wants to go short on Token A, so the concept of the operation is to “borrow tokens and sell them.” Later, if the user is satisfied with the earnings and wants to close the position, whether by borrowing USDT for long trading or borrowing Token A for short trading, in the end, through the trading process, the user exchanges back the initially borrowed tokens and returns them. This is called “closing the position.”
What are the risks of leverage trading?
Leverage trading is not an entry-level experience even in traditional fields. Many professional investors choose lower leverage or even no leverage due to their risk preferences.
Gracy stated that the most fundamental risk of leverage investment is “liquidation.”
Suppose a user invests $1,000 and opens a 5x leverage position, which means the user will have $5,000 worth of cryptocurrency in hand, equivalent to 20% of the initial margin.
If Token A rises by 20%, the user’s assets will become $6,000. The additional $1,000 is the user’s profit, but because the initial investment was only $1,000, the return rate is equivalent to 100%.
However, if Token A drops by 20%, the user will lose $1,000, meaning the initial investment will be completely wiped out. If Token A continues to fall, the $4,000 borrowed from the platform will also be lost together. The platform will then force the liquidation of the user’s assets, selling them to recover the money and interest, which is called “forced liquidation” or “liquidation.”
However, this is a double-edged sword. It is precisely because of the value magnification brought by leverage that the advantage of leverage trading is the ability to increase the trading capital through borrowing funds and expand potential profits. But, of course, amplification applies to both income and losses.
Therefore, leverage trading is more suitable for those with a medium to high-risk appetite who hope to increase their trading capital through short- to medium-term borrowing. It is also a relatively complex financial tool.
The most important advice for beginners when trading with leverage is to control the trading risk and ensure sufficient margin for replenishment. This way, when closing the position, users can choose to add more margin or stop the loss or take profit in a timely manner. These are all things beginners should pay attention to when trading.
Gracy also emphasized that cryptocurrencies themselves are high-risk assets, so investors must “do their own research” and have a clear understanding of what they are doing, as well as their psychological tolerance and risk resistance.
Four future trends for leverage and the cryptocurrency market
Gracy stated that during a bear market, people may prefer leveraged trading because the volatility is relatively weak in a bear market. If investors do not use leverage, there may be less trading opportunities.
In addition, users during a bear market are more likely to be long-term holders or traders with a belief in cryptocurrency. These users tend to have a higher risk appetite, even during periods of poor market performance, and are more likely to engage in leverage trading.
Regarding the future development of leverage trading and the cryptocurrency market, Gracy believes there will be four main trends, which are closely related to regulation and education.
1. Changes in regulatory environment
Countries around the world are now formulating more specific regulatory policies to manage leverage trading and reduce investor risks.
This may include limiting leverage multiples. For example, some countries do not allow leverage exceeding 5x or even prohibit leverage, only allowing users to engage in spot trading. Each country and region will have its own policy requirements, and this trend will continue.
2. Investor education and reminders
It is essential for investors to have a clear understanding of the risks they may face before making trading decisions. Users should be able to know what they are doing and that financial trading risks are controllable while ensuring the security of their assets. Of course, exchanges also hope that users can make money and generate profits, but investor education and reminders are becoming increasingly important trends in the future.
3. Risk management and increased transparency
For example, Bitget Exchange has introduced the Bitget Protection Fund and published Proof of Reserve (PoR) to consider risk management and transparency. They hope to protect the interests of investors and provide more detailed trading information and risk warnings.
4. Increased market maturity
As regulations in various countries become clearer and more institutional investors and professional traders enter the market, increasing market liquidity and depth, the overall market maturity will also improve. With increasing market maturity, volatility may gradually decrease.
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