Crypto leverage vs. crypto derivatives

William Peaster
Feb 04, 2022
|5 minutes read
crypto leverage derivatives

If you’re trading with leverage, you’re borrowing money against collateral to make an investment. As such, people and firms use leverage to make larger investments than they could with just their collateral alone. In doing so, leveraged positions face more risk but also the possibility of greater profits. 

This is multiplier-style trading, as it lets users trade with multiples of the purchasing power of their collateral. For instance, x2 leverage on $100 means you could buy $200 worth of crypto with $100, x5 leverage means you could buy $500 with $100, and so forth.

Another source of multiplier trading are derivatives. Instead of resulting from borrowing against collateral, derivatives are investable financial instruments like options, futures, and perpetuals. These instruments’ values are determined by tracking the performance of underlying assets, like BTC or ETH. 

Derivatives can be complex and exotic in their designs, but ultimately they can amplify risks and returns for investors similar to leveraged positions. What leverage and derivatives share in common, then, is offering traders greater flexibility for speculating on crypto prices and hedging against the risk of volatility in the cryptoeconomy. 

The basics of leverage

We’ve already mentioned how trading with leverage involves borrowing against collateral to make an investment. Two other fundamental concepts to understand when it comes to leveraged positions are margin and liquidations

Margin is the amount of money an investor borrows from a broker in order to invest with leverage. An investment’s worth minus the loan amount is the margin, hence the common refrain “trading on margin.”

As for liquidations, they occur when the value of a trader’s position falls below the value of their deposited collateral. As such, liquidations close positions so that users don’t lose more money than they’ve provided in collateral.

The basics of derivatives

Crypto derivatives can be composed in an endless variety of ways, though to date we’ve seen three main types become popular so far. These types are as follows:

  • Options, which are financial contracts that grant holders the right (though not the obligation) to buy or sell an underlying asset, e.g. ETH. 
  • Futures, which are financial contracts that obligate holders to buy or sell a particular crypto at a later date for a predetermined price. 
  • Perpetuals, which are like futures except they have no expiration date and thus can be held indefinitely. 

Also by DeFi Pulse:

The Binance example

When it comes to considering leverage and derivatives in the context of cryptocurrencies, centralized crypto exchange (CEX) giant Binance is an interesting venue for many traders precisely because it offers services for both these multiplier trading styles. 

Indeed, Binance offers crypto margin trading with up to x10 leverage — i.e. deposit crypto collateral, borrow up to x10 against that from Binance, trade, and then repay — and derivatives instruments like crypto futures and options products

The entrance to the Binance margin trading dashboard. Note the “Derivatives” tab also at the top of the page. 

In being a CEX, Binance actively administers its margin and derivatives markets off-chain. This means making markets, determining and updating its market rules, facilitating loans as a broker, and maintaining its own servers and infrastructure. 

In contrast, there are decentralized exchanges (DEXes) like dYdX that offer up to x25 leverage in permissionless and on-chain fashion, though these dapps can’t provide the range of services and customer support that a large CEX like Binance can. At least not yet, that is!

Using CompliFi to contrast leverage and derivatives

Again, traders can use leveraged positions and derivatives to speculate on crypto prices or hedge against market risks, but these trading styles can provide drastically different trading experiences

When it comes to leverage, you can use a CEX (after you supply Know Your Customer info, of course) like Binance or an upstart dapp like Impermax Finance. However, deposits can never be 100% used because there must be collateral to cover any losses from negative market movements relative to positions. 

On the point of CEXes, we’ve also historically seen numerous historical instances of flash crashes and exchange downtimes resulting in forced liquidations. These possibilities combined with fees and excessive rules can stack the odds against traders. 

Regarding derivatives, the overall idea of, say, a x10 derivative is the same as x10 leverage, namely that any movement in the market impacts your position by x10. Yet in practice the implications are vastly different. 

What I’m getting at is that, in contrast to leveraged positions, derivatives can readily be used for much more exotic and complex positions like indexes or insurance tokens instead of simply multiplying a position’s purchasing power. 

Here, interesting examples to consider are the x5 Leverage Token derivative products by CompliFi, a decentralized derivatives protocol. 

Notably, with these derivatives 100% of the funds in the position can be used, not just the 50-60% range that you typically see with leverage.  These x5 derivatives are also fully collateralized, with the CompliFi automated market maker (AMM) serving as the issuance and settlement mechanism for the products. 

This system shows that streamlined leverage without margin trading is possible with a decentralized derivative, around which no central party exerts control or takes a cut. All the liquidity, and eventually all the fees when set, will stay with CompliFi users. When it comes to multiplier trading, then, rising DeFi projects are at the tip of the spear in charting new compelling ways forward. 

Disclosure: We’ve partnered with CompliFi to help educate and inform the community about derivatives. As always, we’re committed to providing the entire community with quality, objective information, and any opinions we express are our own.