As traders graduate from spot trading to using leverage either through margin trading or futures contracts, they invariably ask themselves “Where or who is providing the leverage?” This article has been created to explain how leverage is granted when trading margin and futures crypto contracts.
What is Margin Trading and How Does it Work for Crypto?
Margin trading is seen as the next step after spot trading. When crypto trading on margin, you post collateral and someone lends you additional funds to purchase the crypto or token you seek. We’ll be using Bitcoin in this example.
Assume you have $100 USD and wish to purchase $1,000 worth of Bitcoin. To complete the trade you need to borrow an additional $900. Various crypto exchanges operate parallel markets where traders in need of additional funds, can borrow from other users. You borrow $900 from the market at an interest rate. The additional leverage was provided by someone with excess USD, and in return, you pay interest.
Your loan has an expiry date. Once it matures, you must either obtain another loan at a different interest rate, or close your position. If you intend to hold the levered position for a long period of time, you have interest rate risk. If rates rise substantially, a significant amount of your equity (the initial total sum of your assets) could go to paying interest, which could lead to the premature closure of your position. Using the above figures – if it cost you 1% per day to borrow $900, you would pay $9 per day in interest. In 12 days, your $100 equity would vanish if the price stayed flat.
Regardless of whether you make a profit or loss, you must pay back your loan. To ensure that you always have enough equity left to pay back the loan, the exchange will set a maximum leverage threshold. If due to losses on your position you breach this minimum threshold, the exchange will automatically close your position and return the principal back to the lender.
How Does Leverage Work When it Comes to Trading Crypto Futures?
Once you are comfortable with margin trading, comes futures trading. Just like trading crypto on margin, trading futures involves leverage. However, unlike margin trading, you do not borrow funds from another user. The leverage is set by the futures exchange.
Here is an example of how leverage works when trading Bitcoin futures.
If you wanted to go long on futures contracts worth 100 Bitcoin, the exchange would require you to deposit a certain percentage of that amount – BitMEX would require one Bitcoin or 1% (excluding fees), but each exchange is different. Both the long and the short side would deposit one Bitcoin.
Trading futures contracts is a zero sum game – you can only win what the loser has deposited as margin. So, if there were no other traders, your maximum gain would be one Bitcoin or 1%. Futures contracts trade on a separate order book, whereas with margin trading you trade on the spot exchange order book. The job of the futures exchange (in this instance, BitMEX) is to bring enough traders together so that the system has enough funds to allow the price of the futures contract to trade at any level.
In margin trading, your holding period is determined by the maturity of your loan. With futures trading, your maximum holding period is determined by the maturity of the futures contract. The price of the futures contract vs. the price of the underlying spot determines the implied interest rate. If you bought a one month futures contract at $32,000, but the spot price of Bitcoin was $30,000, you paid 6.66% interest to borrow funds for the leverage. With futures contracts you know the term interest rate up front, and this rate is locked for the entire duration of the contract.
The futures exchange will specify the minimum amount of equity you must maintain. If you breach this threshold, the exchange will close a portion or all of your position. They do this to ensure there is enough equity to settle all outstanding contracts at maturity. The more leverage the exchange grants, the harder it is to ensure orderly settlement of outstanding contracts.
Here is a Table That Summarises Crypto Trading Margin and Futures Contracts
| Margin Trading | Futures Trading |
Leverage | Borrowed from others | Set by the exchange |
Interest Rate Risk | Variable interest rate | Fixed interest rate |
Order Book | Spot | Futures |
Maximum Holding Period | Determined by the loan maturity | Determined by the settlement date of the futures contract |
For more educational resources on trading at BitMEX, we invite you to head here for our growing portal of educational guides that cover trading, and the wider cryptocurrency ecosystem.
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Related
FAQs
The leverage is granted by borrowing funds. Traders can leverage by taking either a long or a short position. If the position succeeds, they receive higher funds than they would by trading on the spot. If the asset price falls too low, a margin call may be issued, and the trader may be forced to liquidate.
How does leverage work in crypto futures? ›
In the cryptocurrency market, trading with leverage works on the same principle as in the Forex market. The broker provides the trader with borrowed funds to amplify their trading position, allowing for potentially larger profits compared to trading with only their own capital.
How much leverage is in a futures contract? ›
Leverage is the ability to control a large contract value with a relatively small amount of capital. In the futures market, that capital is called performance bond, or initial margin, and is typically 3-12% of a contract's notional or cash value.
What is 100x leverage in crypto? ›
What is 100x leverage in crypto? 100x leverage in crypto means a trader can open a position worth 100 times their original investment, significantly amplifying potential gains or losses from small price movements.
How to calculate crypto leverage? ›
The effective leverage is calculated by dividing the value of open positions by the total available equity of the account. In other words, the effective leverage is the amount of capital used compared to the amount in the futures trading wallet.
How much leverage is in crypto? ›
Leverage trading in crypto is a powerful tool for traders to increase their potential returns and profits. It allows them to open positions with less capital than would otherwise be required, by providing access to leverage ratios of up to 100 times the amount invested.
How does leverage trading work? ›
When you trade with leverage, you gain full exposure to the full trade value with a small initial outlay. Therefore, your profits and your losses are amplified. This means you can lose more than your initial outlay amount and may need to add additional funds to keep your trades open. This is known as a margin call.
What is margin and leverage in futures trading? ›
The sum amount invested by an individual, including the collateral provided is called the margin, and this practice develops a trading power called leverage. Margin is majorly used to gain and generate high leverage that has the ability to increase both profit and losses.
What is the margin on a futures contract? ›
Margin money is a deposit to secure a futures position while it is open. Margins must be maintained at the level required by the brokerage firm. When the futures position is closed, the remaining margin money after trade settlement can be returned to the account holder.
What is the best leverage for futures trading? ›
A leverage of 2x or 5x would be considered appropriate for those who are new to futures trading. This allows you to gain exposure to the market while limiting your potential losses.
MEXC offers some of the highest leverage crypto trading limits in the industry at 200x. This means that for every $100 staked, you can access up to $20,000 worth of trading capital. We like that MEXC supports a wide range of leveraged futures markets covering everything from stablecoins, web3.
What is 10x leverage in crypto? ›
Scenario 1: 10x Leverage
Imagine a trader with an initial margin (or collateral) of $1,000. The crypto exchange they are trading on offers them a leverage of 10:1, commonly referred to as 10x. This means that the trader can hold a position worth $10,000, despite only having $1,000 in their account.
Is 10x leverage risky? ›
While leverage can amplify your gains, using too much of it, especially ≥10 leverage, can lead to significant losses and jeopardize your trading capital. Here's why you should avoid using high leverage like ≥10: 1. Risk Management: High leverage increases the risk of margin calls and potential account blowouts.
What happens if you lose a leverage trade in crypto? ›
For example, a 10% drop in value on a 10x leveraged trade could force the exchange to liquidate your collateral. Price moves of 10% or more aren't unusual in the crypto trading world, so higher leverage brings a greater risk of liquidation.
What is an example of futures leverage? ›
For example, if a crude oil futures contract represents 1,000 barrels and, if crude is trading $55 per barrel, the size of the contract is $55,000 (1,000 x $55). If margin is $4,350, or roughly 8% of the contract size, that amount is the maximum leverage when trading one oil futures contract.
Does 5X leverage mean 5X profit? ›
For instance, with a 5x leverage, you can purchase 5 times more shares. And if the market moves in your favour, you stand to gain 5 times more return on your investment.
What is 20x leverage on $100? ›
Opening a trade with $100 and 20x leverage will equate to a $2000 investment.
Does 5x leverage mean 5x profit? ›
For instance, with a 5x leverage, you can purchase 5 times more shares. And if the market moves in your favour, you stand to gain 5 times more return on your investment.
What is 20x leverage in crypto? ›
What is 20x leverage in crypto? With 20x leverage in crypto, you can get up to 20 times your initial margin deposit. For example, if you deposit $1,000 in a crypto account, you could access a leveraged position of up to $20,000.
How do you use leverage in futures? ›
How Does Leverage Work in Futures Trading? In futures contracts, leverage is used to amplify the potential returns from changes in the price of the underlying asset. It is a double-edged sword that can significantly increase potential profits and potential losses.
