Leveraged trading of cryptocurrencies — i.e., trading crypto with borrowed funds — comes with significant risks. This is mainly due to the capricious nature of the market.
In May, the cryptocurrency market, which had grown significantly over the past couple of years, recoiled violently following a cascade of negative market events, losing over 50% of its market cap. The pullback, which caused a jarring $2 trillion market wipeout, also exposed some of the market’s biggest weaknesses. One of them was the reckless use of leverage in a market that is historically mercurial.
This aspect was recently affirmed by billionaire investor Mike Novogratz. Novogratz, a fierce crusader for the industry at large and a once-ardent supporter of the Terra ecosystem before its downfall.
He recently acknowledged that he underestimated the amount of leverage in the market and the losses that this would bring.
“I didn’t realize the magnitude of leverage in the system. What I don’t think people expected was the magnitude of losses that would show up in professional institutions’ balance sheets, and that caused the daisy chain of effects,” he said.
Speaking to Cointelegraph earlier this week, KoinBasket Founder and CEO Khaleelulla Baig, reinforced the view that the market was indeed overleveraged and will take a while to recover:
“Crypto markets are still in R&D phase, and we shouldn’t be surprised to see a few more crypto projects going bust, especially those built around collateralization and leverage.”
He added that regulators were likely to look into the leverage loophole in order to protect investors, stating, “Albeit these events have opened doors for regulators and industry participants to build robust mechanisms to avoid such catastrophes in the future.”
What is leverage?
Leverage refers to the use of borrowed capital to trade, and is usually the preserve of professional traders with significant experience in risk management.
To trade leveraged products, investors are usually required to make a minimum deposit with a broker that supports this type of trading. Platforms that support margin trading effectively lend money to investors for the purpose of opening bigger positions.
Positions that are held beyond a certain amount of time incur interest fees that are deducted from the money held as collateral. The charges usually vary and are based on the amount of money extended to open margin positions.
Since profits and losses on margin accounts are based on the full…
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