Leverage & Crypto Currency
Before we get into the nitty-gritty of what leveraging using crypto currency entails, it is important to first understand what leveraging means.
To those who are not savvy in stock markets, I will try and give a definition that is simple without the use of technical jargon. Leveraging refers to the manner in which one may use any asset in order to increase value and returns based on future earnings. In terms of finances, this would imply using different financial instruments in order to borrow capital to increase the future return on an investment. It can also refer to the level of debt a company holds as it secures assets for its operations.
To get a proper perspective of how leverage works, a hypothetical example would serve to explain it. Let us suppose a person has $10,000 in cash and wants to purchase an asset worth $100,000. Based on the cash they have, the difference of $90,000 would have to be borrowed in order to purchase the asset. Using the borrowed $90,000, they are able to buy an asset with more value than if they had chosen to buy an asset worth $10,000. When analyzed from the perspective of investing, the buyer has leveraged 10 to 1. This means that they have borrowed $1 for every equivalent of $10 cents of their money spent.
Leveraging using crypto currency works on the same protocols used in traditional stock and financial markets. It allows one to trade on significantly larger amounts than what they may be holding. The maximum leverage that most crypto currencies allow is 50:1. This may be lower than the traditional leveraging. This is because the markets for crypto currency are more volatile than the traditional markets. One can use their crypto currency to leverage and trade on other crypto currency on several multiples which are higher than their holdings.
Margin trading allows the holder of crypto currency to use their account balance to buy more crypto currency than their account balance. If for example, one has $5000 worth of crypto currency, they can leverage up to 50% and buy $10,000 worth of new crypto currency. That is a leverage of 2:1. This form of margin borrowing attracts a margin fee for the borrowing. If the balance on your account falls below the minimum requirement, the exchange or crypto currency platform may make a margin call. This is normally the “Maintenance Margin Requirement” and may result in the lender liquidating the assets held.
The substance of leveraging using crypto currency is that it allows you to obtain significantly more crypto currencies based on what you hold. Leveraging by nature involves taking risks on how the market may perform in the future. In case the market appreciates, there are gains to be made. On the flip side, you also stand to lose on your crypto currency. It is advisable to start leveraging with small levers in the learning which is progressive.