Steemit Crypto Academy Contest / S13W6 - Leverage in cryptocurrencies.

Hello wonderful global community! It's a pleasure to share my understanding of the given topic with you and I anticipate to get benefited from your feedback. Let's move straight to the specifics of the given task.

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In your own words, what do you understand by leverage?

KoFor a while, let's set finance aside. Leverage would mean support, in simple terms, to achieve desired results. A lever is a tool used to move heavy objects, which isn't manually possible. So, the idea that we get from the term "lever" or leverage is that something is used to support the existing resource to achieve more desired results than what could be achieved without support.

Now, let's make our discussion finance-specific. Leverage would refer to the use of borrowed funds from a third party with the intention of achieving more profit than what could be achieved with the available capital of a borrower. Let me give you a simple example. Suppose I have $1 of my own and borrow $9 from someone to make an investment of $10. It means I took 10x leverage from someone to make my available capital 10 times more than what I had in my hand before borrowing. I can sey that I took leverage of 10x from someone.

Explain how leverage works.

Leverage is always taken with the intention of making more profit, but it is highly important to consider the other perspective—that is, the greater loss that one can experience if a trade or investment doesn't go in the desired direction.

Let me explain the working of leverage. Suppose I have my own capital of $100, and Exchange X is offering me leverage of 10x. It means that I can make an investment of $100 * 10 = $1000. So, I should be ready for two possibilities resulting from the above investment.

Let's presume that my $1000 investment gives me a profit of 10%, which means I'll be in a profit of $100. So, with my initial capital of $100, I was able to earn an additional $100 with the help of leveraged funds. With only a 10% profit, I doubled my capital, which wouldn't have otherwise been possible only with a 100% profit if I used my own capital without leverage.

The second scenario we have to consider is a 10% loss on the $1000 investment. In that case, I will suffer a loss of $100, meaning all my capital would vanish. If I had not taken the leverage, I would have only suffered a loss of $10.

The advantage that the borrower gets is that of an additional transaction fee that is charged for taking leverage. For 10x leverage, one will have to pay a transaction fee significantly higher than what they would have to pay without leverage.

Why is leverage used in cryptocurrencies?

Leverages are almost always used with the intention of gaining more profit than what would have been possible with one's own capital. As explained in detail in the above example, the functioning of leverages can gain more profit with a small capital. It is essential not to overlook the fact that losses are also increased.

With 10x leverage, profit is 10 times more for a desired investment, and so is the loss. Therefore, the sole purpose of using leverage is to attain more profit while being able to have greater capital and larger investments as well. Burrower aims to get more transaction fee.

If you want to open a long position and you have 12,000 USDT in Steem and a leverage of 10x. Explain if the price of Steem rises by 45% and then explain if the price drops by 15%. Give your own opinion.

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Scenario one - 45% up

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Having opened a long position, a 45% increase indicates the position is moving favorably, yielding profits. Let's calculate the profit both without leverage and with leverage.

• Profit without leverage

Assuming a long position opened at a Steem price of 0.25 with a capital of 12,000 USDT, I'd receive 48,000 Steem tokens. With a 45% increase, the new Steem price would be 0.36 USDT. Closing the position at a 45% profit would yield me a total of 17,280 USDT, resulting in a $5,280 USDT profit from the initial 12,000 USDT.

• Profit with leverage

With 10x leverage and a capital of 12,000 USDT, I'd acquire 480,000 Steem because my capital would be 1 20 000 USDT . A 45% price increase with leverage would amplify the profit by 10 times, resulting in 32,800 USDT profit compard to 3280 USDT.

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Scenario two - 15% down

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As I've opened a long position, a 15% decrease implies incurring a loss.

Loss without leverage

Assuming a long position with a 12,000 USDT capital at a Steem price of $0.25, resulting in 48,000 Steem tokens. With a 15% price decrease, the new Steem price would be $0.21. Closing the position at this price would yield me a total of 10,200 USDT, reflecting a 1,800 USDT loss.

Loss with leverage

With 10x leverage and a 15% price decrease, the loss would be increased by 10 times. In the previous case, the loss was 1,800 USDT, but with 10x leverage, it would amount to $18,000 USDT.

I hope the concept is now crystal clear.

Mention the advantages and disadvantages of leverage.

Having thoroughly discussed the concept of loss and gain, along with examples, let me enumerate the advantages and disadvantages of leverage for the sake of completing this task.

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Advantages of Leverage

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1. Increased Profit Potential:
   Leverage trading provides more profit when the trade goes in a favorable direction. The projecred profit is proportionae to the numerical value of leverage, for example, a 10x leverage could yield 10 times more profit compared to trading without leverage.

2. Short Selling:
   Short selling is not possible in the spot market, but it is achievable in leverage trading (futures/margin/options). It involves selling tokens without previously owning them. If we short sell a position and market goes down, it would yields us profit in a falling market.

3. Hedging:
   Hedging is an advanced trading technique to minimize losses in case of an unfavorable market move. Let me briefly tell you how it works .suppose a trader opens a long position and market starts reversing, then a taders can open a short position simultaneously with a long one to mitigate potential losses. Hedging has various strategies like stradle and strangle etc.

4. Open Multiple Positions - Diversification:
   Leverage provides traders with more purchasing power, allowing them to open multiple positions in different tokens to diversify their portfolio.

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Disadvantages of Leverage

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1. Greater Loss:
   While leverage can increase profits, it also amplify losses. For instance, a long position with 20x leverage can result in a 20 times greater loss if the token's price falls than loss without leverage.

2. Liquidation Risk:
   Liquidation is a safety mechanism used by borrowers to automatically close positions when the liquidation price is reached. With leverage, the risk of liquidation is higher due to increased losses accrued our of increased position size.

3. Transaction Fees:
   Leverage increases position size proportionally, leading to higher transaction fees. Consequently, traders using leverage will incur more substantial transaction costs than without leverage as position size is less with later.

4. Market Liquidity:
   Leverage allows traders to open position size greater than what would be possible with their own funds, contributing to increased market liquidity and increased liquidity can result in greater volatility, leading to increased risk of both profit and loss.

Conclusion

Leverage enables the use of borrowed funds for trading or investing with the intention of gaining more profit. While it's true that leverage can increase profits, it also introduces the risk of greater losses. Leverage itself is not harmful, but the dominating factor of greed can be troublesome when open positions do not go in the desired direction.

Thanks.