How Cryptocurrency Traders Use Leverage

The following post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga.

As an asset class, cryptocurrency has evolved substantially in the past decade. With the introduction of increasingly sophisticated speculative platforms and trading instruments, the crypto trading environment is a far cry from the handful of savvy buy-and-holders that constituted the initial investors in bitcoin, ethereum, and other coins.

Despite the influx of investment vehicles and exchanges that now support digital assets, one of the most popular means of speculating on cryptocurrency remains forex-style contract pairs. This means using margin to speculate on the spread between a cryptocurrency and another asset, which makes the most of the asset’s historical volatility without requiring traders to buy the actual asset.

However, this type of Contract for Difference (CFD) trading can introduce a good deal of risk to a trader’s portfolio. It’s for that reason traders should have a full accounting of the role margin and derivatives play in the contemporary cryptocurrency market.

The ABCs Of CFD

Contract For Difference trading is among the class of financial terms that does exactly what it says on the tin. Essentially, traders using CFDs are purchasing long futures contracts for an asset—let’s say bitcoin—that will ultimately be fulfilled by another denomination—say the U.S. dollar. The contract itself may become more or less valuable based on the increase or decrease in difference between bitcoin and the dollar.

Cryptocurrency traders gravitate CFDs because they don’t require them to put up full funding for the underlying assets in the trade. While the contracts do represent ownership of the underlying asset, many contract brokers such CryptoRocket only require traders to fund a fraction of the total contract value through their account and provide the remaining funding on margin. This means traders can take an outsized contract position in the spread between two assets and sell once they’ve realized their target profit.

Despite this convenience, traders shouldn’t lose perspective that they are still holding the underlying assets during a trade, even if it is just on paper. This means that, while traders using a broker like CryptoRocket need only put up 1% of a cryptocurrency contract’s full value, they are still carrying the full risk of the trade. While there is no cap to how much can be made trading these assets, there is also no floor to how much can be lost.

This outsized risk is why some countries like the United States have regulations banning brokers located in their nations from engaging in CFD trading. It is also why it is strongly encouraged that traders over-fund their accounts and utilize stop-loss orders to avoid losing more than they can afford and incurring a margin call. Because while CFDs do carry a good amount of risk, smart, well-executed CFD trades can also produce outsized profits.

An Illustration

Let’s take a look at a timely example of how cryptocurrency CFD trading works, using the current spread in BTC/USD on CryptoRocket as our guide.

Let’s say you were interested in the BTC/USD pair and you felt the price of bitcoin will go up above $7,600. Using margin, you purchase a contract for 1% of the current ask—$7,445—which means you will need a minimum of $74 to fund the transaction.

In the event that bitcoin does rise above your $7,600 target, let’s say you can exit at exactly $7,645, your profit from that would be $200 on your initial $74 investment, which after CryptoRocket’s flat $6 margin fees comes to $194 net profit.

Of course, should bitcoin fall to say $7,380 the loss would essentially wipe-out your initial capital ($74 - $65 = $9). You can see how this could be a problem if the loss extends beyond the capital in your account. Should that happen, it can eventually lead to what is called a margin call and your account holdings could be forfeit until the broker is able to settle your remaining margin. This is the main reason why most cryptocurrency traders placed a stop-loss order.

Of course, traders who are eligible to trade CFD and who practice due caution to minimize loss and ensure account funding can reap outsized returns with the strategy. Like with all trading, it's simply critical they understand the full degree of risk posed by any trading vehicle.

Risk Warning: Trading leveraged products such as Forex and CFDs may not be suitable for all investors as they carry a degree of risk to your capital. Please ensure that you fully understand the risks involved, taking into account your investments objectives and level of experience, before trading, and if necessary seek independent advice. Please read the full Risk Disclosure

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The preceding post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga. Although the piece is not and should not be construed as editorial content, the sponsored content team works to ensure that any and all information contained within is true and accurate to the best of their knowledge and research. This content is for informational purposes only and not intended to be investing advice.