What is Leverage in crypto trading?
Leverage represents the process of utilizing borrowed funds to trade cryptocurrencies. Leverage increases users buying power, enabling them to open larger positions with the same level of personal capital. In the context of leverage, the initial personal capital is referred to as margin because this capital is a form of collateral. A broker may provide loans to traders that use the borrowed funds to increase exposure to a specific position and enhance potential profitability.
Leverage can be used for opening long and short positions. Leverage is commonly expressed as ratio such as 1:5 (times 5), 1:20 (times 20); 1:50 (times 50), etc. Crypto exchanges and trading platforms may offer a leverage of up to 1:100, while some may offer even higher leverage. The leverage ratio of 1:100 indicates that traders can borrow up to 100 times of their trading capital available in their accounts. Hence, the size of available leverage depends on the specific trading platform and the crypto that will be traded.
A trader with $100 and a leverage ratio of 1:20 can potentially open a position worth $2,000. Therefore, his/hers buying power is $2,000 even though the trader has $100 of his own capital, which indicates a trading margin of 5%. Leverage is considered a risky method for trading because although it can increase profit, it can also augment losses.