From: thepipeline_xyz
Leverage in crypto trading presents both significant opportunities and considerable risks, often leading to volatile market conditions and unexpected consequences for traders and institutions alike.
Dangers of Leverage and Counterparty Risk
During extreme market events, the impact of leverage can be severely amplified, creating chaotic trading conditions and exposing participants to unforeseen counterparty risks.
The COVID-19 market crash, for instance, saw Bitfinex effectively pull the plug on its exchange, with prices briefly going to zero. [00:32:09] Similarly, FTX experienced operational failures at market lows. [00:32:15] During this period, the basis for Ethereum (ETH) futures experienced extreme volatility, moving 20% up or down within half an hour, not on an annualized basis. [00:32:21]
Systemic Risks
The instability extended beyond individual trades. The underlying trading venues themselves were “falling down,” making it difficult to assess counterparty exposure. [00:32:50] When major entities like Three Arrows Capital collapsed, numerous lenders in the crypto space began to fail. [00:32:55] In the aftermath, it was impossible to know which exchanges or counterparties were solvent; many faked their solvency and only survived because the market rebounded. [00:33:01]
The ripple effects of leverage can be profound, creating second and third-order effects in related markets that are often unclear until they materialize. [00:48:57] For example, the collapse of one lender can lead to a cascading failure where every lender effectively dies, demonstrating that spreading out borrowing across multiple entities might not truly hedge risk. [00:49:04]
Advice on Leveraging and Trading Frequency
Dan Metvi, co-founder of CMS Holdings, strongly advises against using leverage, particularly for younger individuals. [00:48:26] He notes that even CMS Holdings was negatively impacted by lenders failing in 2022, forcing them to unwind positions at disadvantageous levels. [00:48:32]
Additionally, a common pitfall for traders in the crypto industry is over-trading. [00:49:15] Many individuals feel compelled to constantly trade, leading them to undo their own sound investment decisions. [00:49:50] If a trader has a strong thesis, it’s often more beneficial to “trade less” and simply wait for the market to move in their favor. [00:49:17]
The “Selection Bias” of Leverage Success Stories
Despite the inherent risks, many individuals are drawn to leverage because they predominantly hear about the few who “make it” using it, rather than the vast majority who get “carried out.” [00:50:16] This creates a selection bias where success stories are amplified, masking the widespread failures that often accompany aggressive leverage strategies. [00:50:26] Even prominent figures and entities like Three Arrows Capital and Celsius saw their downfalls linked to excessive leverage. [00:50:37]