The Hidden Risk In Crypto Trading: Leverage Can Hurt You Fast
Tokenization addresses liquidation by converting traditional crypto tokens into inherently leveraged tokens. This removes the risk of being liquidated in a traditional futures or derivatives trade. In other words, rather than a liquidation price being triggered, the asset merely continues to depreciate. This removes the risk of a liquidation event. However, not the potential loss of capital.
If you have spent any time trading with leverage in the crypto markets, you will be able to confirm a very real reality: leverage is great, but sometimes it really hurts! Being on the right side of the market in a leveraged position feels great, and the gains begin to appear almost magically. Seeing that dollar or satoshi amount climbing sends many into a state of euphoria.
However, it can be absolutely devastating. If you are reading this and have only ever bought actual tokens or coins and stored them in a wallet, you will not be able to appreciate the magnitude of the situation. If you think drops in crypto are harsh, imagine multiplying those numbers by 5, or even 100.
Why Exchanges Have Adjusted Leverage Offerings And How It Affects Traders
Due to regulatory concerns, most exchanges, including Binance, recently reduced their maximum leverage to 20X the principal amount. Previously, these exchanges offered up to 100X, which in the crypto space is crazy! Unlike holding a coin, which, if the value drops, you still have your asset, a leveraged position is different. When the value drops far enough in a leveraged position, the position is liquidated, leaving the trader with nothing.
As an example, if you are trading with 5X leverage and the price moves 20% against your position, you are out. Whatever you invested is now gone, with absolutely no possibility of returning. It’s gone for good! However, you will usually receive a margin call warning you to increase your allocation to avoid liquidation. Depending on how aggressive the market move is, you may not have enough time to fund your position.
Why Leverage Is A Dangerous Game In Crypto And Financial Markets
This all sounds very dangerous and rather risky. For those of us who use leverage, we do so sparingly. I, fortunately, had a lot of experience trading with leverage in the forex market. It took many years, but eventually, I figured out a pretty sound approach.
Unless you have a very strategic approach to leverage, you will most likely lose. Things can go horribly wrong very quickly! This is obviously due to your losses being magnified by your leverage.
What If You Could Avoid Liquidation
Imagine you could open a leveraged position without risking liquidation. This sounds like a dream to the maybe not-so-skilled futures trader. Instead of being liquidated, the position would just continue to lose value. In this case, it would be an actual token. I am talking about leveraged tokens on exchanges.
These leveraged tokens are rebalanced every 24 hours, so the possibility of actual liquidation is almost zero. Let’s take a closer look at one of these tokens.
The LINKBULL 3X Token
The LINKBULL token is leveraged at 3X the daily move. For example, if LINK went up 10% on a day, the LINKBULL token would appreciate by 30%! The same is true for a move towards the downside; the token would then decrease in value.
What you are witnessing here is the effect of compounding. When the market enters a bullish phase, gains compound week after week and sometimes month after month. This is when the token reaches phenomenal highs. The extreme lows are obviously when the trend is bearish.
What Are The Benefits Of Leveraged Tokens In Crypto Trading?
Given the massive potential in a market that has secured its direction, capital allocation need not be significant to ensure gains. Although sideways price action is not good for such an instrument, a market that is set in a particular direction for some time can multiply profits at an alarming rate.
A typical 3X-leverage trade would be liquidated when the market moves 33% against it. In the case of 3X tokens, they simply continue to lose value. As mentioned earlier, prices can recover from devastating lows, as they can drop from euphoric highs.
Both BULL & BEAR
These tokens are available as both BULL and BEAR tokens, meaning you can profit from both a bull and a bear market. As mentioned earlier, these instruments perform exceptionally well once the market has entered a long-term trend, ultimately securing ongoing profit compounding.
These are fun instruments to utilize with small or discretionary amounts. However, they are extremely volatile and should only be experimented with by those with some prior experience with leverage. Although liquidation is unlikely, losses can be massive and subsequently rather difficult to recover from.
Risks Associated With Leveraged Tokens – What Crypto Investors Should Know
It is important to be aware of the dangers and benefits of leverage. Essentially, all market moves are amplified, whether up or down. This can be great when market movements are aligned with your position or strategy. However, when the opposite is true, losses are compounded. In the case of leveraged tokens, although a liquidation event is extremely unlikely, severe losses can still be incurred, unlike with traditional leveraged products.
If the market moves against your position for a lengthy period, losses can reach the point of no return. Any leveraged products carry significant risk, especially within the crypto sector, as many projects suffer the damaging effects of bear markets and even ultimate failure. Ensure you are well aware that extreme losses can occur in all markets when leveraged products are used, not just gains.
Conclusion
The clear benefits here are that liquidation can be avoided while still using leverage. Furthermore, once a trend is in motion, purchasing the appropriate leveraged token can lead to gains that reach astronomical heights. The fact that these are actual tokens is another benefit. In other words, these are not paper contracts or CFDs but rather actual assets that you can take custody of. The downside is that losses can compound quickly if you are positioned against the market’s flow.