Can extreme leverage crush the crypto market in 2022?

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Leverage can be both a good and a bad thing. On the January 5 episode of “The Crypto Show” on Backstage Pass, Fool.com Editor-in-Chief Eric Bleeker and Contributor Chris MacDonald discuss how leverage could impact the outlook for major cryptocurrencies. currencies in 2022.

Eric Bleeker: Let’s start with the leverage segment that Chris just alluded to. We have an article, “Leverage-Linked Liquidations Pummel Solana (CRYPTO:SOL), Polkadot (CRYPTO:DOT), and The Sandbox (CRYPTO:SAND) Today.”

What’s behind all this?

Well, we talk a lot about leverage, and it’s a specific product that we’re looking at that is part of that leverage situation. And as you can see, this is from Bitfinex, it’s a maximum leverage ratio of 100x, so there’s a little screenshot of some of the numbers behind what we’re talking about.

Chris, let’s talk about this article. What do you currently see in the space and how is leverage driving recent price activity?

Chris MacDonald: It’s really interesting. When it comes to the derivative side of the crypto world, in the stock market there have been many recent rallies, there has been a lot of analysis done in the options markets that determine the share price of something like a Tesla ( NASDAQ: TSLA), for example, with call options forcing market makers to buy stocks and thereby driving up the price of certain stocks.

In the world of crypto, there are derivative products that may not be as well known to some retail investors. These products are intended for use by institutional investors and traders and to use them you must be an accredited investor, so it is not necessarily within the purview of many retail investors per se. But it is an interesting trend to watch with what is driving volatility in the crypto market.

Diving into it a bit – I’m still learning about this too because there are so many different variations – Bitfinex is one of the biggest players in this space so looking at their 100x leveraged product it is a perpetual contract. Essentially, an investor can put up 1/100th of the capital they want on a trade to try to catch the upside, for example, on a particular token. If they stake $100, say, and the given token moves up 1%, they would earn $100 on that trade, so you double your money on a 1% move.

On the downside, it happens the same way. Bitfinex has, for various contracts, different margin requirements, but essentially if it drops 0.5%, a forced liquidation is in place. The article I wrote focused on the forced liquidations driving the volatility of these three tokens highlighted in this article.

Essentially, it’s interesting because it’s one of the factors that’s been reported to create volatility in the crypto market, because while a 0.5% drop can force sell-offs on all those contracts, this essentially translates into new sales that even drive the price down. any further. Some of the spikes we’ve seen are partly driven by these upside contracts, but on the downside it also increases volatility any time you have 100x leverage on something.

This is just a really interesting tidbit to think about when looking at the crypto market in terms of why is crypto so volatile? This is a question a lot of people are asking and a lot of it is due to some of these contracts that are available right now.

Bleeker: You’re thinking 100:1 leverage. I know you just put it in perspective, but it really is incredible leverage. Even on the heaviest financial products in the world, you can hardly imagine 100:1 leverage, let alone somewhere like crypto, so it’s almost hard to conceptualize that amount of leverage offered, is not it ?

MacDonald: Yes, of course. Again, thinking about how a half percent move could liquidate your position, these things are obviously for sophisticated institutional investors looking to hedge a position or add risk to their portfolio.

When you talk about this on a large scale, it can really generate volatility, so that’s one of the things retail investors should perhaps think a little bit about in terms of what’s going on behind the scenes.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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