Cryptocurrencies like Bitcoin and Ethereum have seen tremendous growth in popularity and adoption over the past few years. However, investing in crypto also comes with significant risks. One major concern for many potential investors is the possibility of losing more money than you originally put in.
What is crypto leverage trading?
Unlike regular cryptocurrency trading where you are only risking the amount you invest, leverage trading allows you to open much larger positions with borrowed funds. This is done by taking on leverage from the exchange or broker you are trading with. For example, a 1:10 leverage ratio means you can trade with 10 times the capital you have in your account.
Leverage magnifies both gains and losses. If the trade goes your way, leverage boosts your profits. But if the market moves against you, leverage will greatly amplify your losses. With high leverage, it’s possible to lose your entire capital and more if the market drops sharply.
How you can lose more than you invest
There are two main ways you can lose more than your initial investment when trading crypto on leverage:
Liquidation
Exchanges will automatically liquidate your position if your account equity falls below the margin maintenance level. This prevents you from building up too much debt to the exchange. For example, if you have $1,000 in your account and take a 1:100 leverage trade, the exchange may liquidate your position if your equity falls below $200.
If the market moves sharply against your leveraged position, you may lose your entire capital and still owe the exchange for the borrowed funds. You would need to deposit additional funds to cover the losses.
Gap Risk
Cryptocurrency markets are volatile and gaps up or down can happen, skipping price levels. If the market gaps down and liquidates your leveraged long position, you may incur losses greater than your capital. This risk is higher over weekends or when trading altcoins with low liquidity.
For instance, if you have $1,000 in your account and open a 1:100 long position at a price of $10,000, you are controlling an equivalent of $100,000 in cryptocurrency. If the market gaps down 20% to $8,000 over the weekend, your position would get liquidated at a $20,000 loss while your capital was only $1,000.
Real examples of losing big on leverage
Unfortunately there are many real-world examples of traders losing more than they invested when trading crypto on leverage. Some examples include:
May 2021 BTC crash
In May 2021, Bitcoin dropped from around $60,000 to below $30,000 in a matter of days after China imposed new bans. The rapid crash liquidated over $12 billion worth of futures contracts on exchanges like Binance, BitMEX, and Deribit according to Bybt data. Some traders lost everything and owed tens of thousands to their broker.
Alex Cranberg in January 2022
19-year old Alex Cranberg borrowed $55,000 on 8:1 leverage from crypto trading platform Futureswap to long ETH at around $3,500 in January 2022. When Ethereum plummeted 33% to $2,300, his entire capital was wiped out and he owed over $100,000 to Futureswap. Unable to repay, Futureswap closed his account.
3AC hedge fund summer 2022
Major crypto hedge fund Three Arrows Capital (3AC) took on leverage across different protocols like Aave and MakerDAO. When crypto markets crashed in June 2022, 3AC was liquidated and unable to meet margin calls. The firm filed for bankruptcy with over $3 billion in liabilities and just $70 million in assets.
Risk management for leveraged crypto trading
Leverage can be a powerful tool to amplify gains but also losses if not used properly. Here are some tips to manage risk when trading crypto on leverage:
- Start with low leverage ratios like 1:5 or 1:10 and use tighter stop losses.
- Trade with reputable exchanges that have robust risk management systems.
- Diversify positions across uncorrelated assets rather than going all-in.
- Use leverage for intraday trading only, not long term holding.
- Monitor your positions closely and adjust leverage based on market conditions.
- Cap your maximum loss per trade to a percentage you can afford like 5% of capital.
Conclusion
In summary, it is certainly possible to lose more than your initial investment when trading cryptocurrencies on leverage. This risk comes primarily from liquidations and gap moves that wipe out your capital before you can exit. While leverage can amplify profits, inappropriate use can also multiply losses in a volatile crypto market.
Leverage trading should only be done with great caution. Start with small positions, use tight stop losses, and limit your maximum risk per trade. With proper risk management, leverage can be utilized safely and profitably in crypto trading.