Key Takeaways
Leverage is the amount of borrowed funds used to potentially increase return on investment (ROI).
Leverage is used to increase buying power and financing assets.
Leveraged debt is tax-deductible.
Leverage increases the potential profit and potential loss.
What Is Leverage?
Leverage is taking on debt by using borrowed money for investments. In crypto, leverage is the amount of borrowed funds used to potentially increase the return on investment (ROI) when trading coins or tokens.
Using Leverage
Leverage is used to increase buying power and finance assets. A simple example of using leverage would be a company taking on debt by borrowing money from a bank to buy resources that facilitate growth. Resources could be an office, equipment, expanding operations, etc.
The way crypto investors use leverage is by borrowing from a broker – typically, the exchange they use to buy crypto – to increase their investment capital. This creates the opportunity to buy more crypto, which can produce a higher yield.
Calculating Leverage
Calculate leverage using the formula below:
total debt / total equity
A company that has a total debt of $100,000 and a total equity of $150,000 would calculate leverage as follows:
leverage = 100,000 / 150,000
The result (0.66) would be the company’s leverage.
In the crypto world, using margin trades – borrowing capital to from a broker, such as Coinbase, to invest in coins – results in leverage.
Summary
Leverage is a critical component of crypto trading. It can be a great way to increase the return on investment if used with caution. It’s not typically recommended for beginner investors to utilize leverage, at first. Only after getting a good handle on basic investing and trading should leverage be used, and it should be used with caution as it can also cause huge losses.