LEVERAGE IS A DISASTER IN THE MARKETS
I think I've said it enough times: don't use leverage, don't try Futures, you'll only lose your money. I can assure you of that. But that's not what I want to talk about this time. I want to talk about the impact of leverage on movements in the crypto markets. Pay attention, as this is crucial to understand.
First of all, understand how leverage works: imagine you open a trade to buy with $100 with 10x leverage, it will act as if you had $1,000. How does this work? The exchange (like Binance) will simply lend you $900, and in exchange for that, if the price drops by 10% (so your $1,000 turns into $900), your position is automatically closed to prevent you from being indebted to the exchange. You are what is called "liquidated".
When you are liquidated on a long position, at the moment of your liquidation, it instantly creates a market sell: this means that your remaining $900 is sold off so that Binance can recover its money.
Now, let's take this phenomenon and apply it on a much larger scale: imagine that 10,000 people enter long with 10x leverage on BTC at 3 different levels: at $65k, $67.5k, and $70k. Now, imagine that the price drops to $63k, so -10% from $70k. The people who entered will get liquidated and will thus trigger massive sales in the market, which will strongly push down the price of BTC, which will then go down to $60,750 due to massive liquidations, which will trigger the liquidations of those who entered at $67.5k, and so on... This is called cascading liquidations.
When too many people enter the market with leverage, it creates a risk of very strong and rapid liquidations, which can create "flash crashes", that is, moments of a few minutes where BTC can lose -20 or -25%. This is also the same in traditional finance, on the scale of banks/hedge funds etc, but that's another topic.
Thank you for reading.
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Livio P-V.
