Within a day, the biggest crypto exchanges FTX and Binance have announced that they are reducing the limit for futures trading to 20x. The announcement came via tweets from the respective founders. While FTX’s Sam Bankman-Fried took the first step, Binance’s CEO Changpeng Zhao wasn’t far behind. What’s worth noting is that both these exchanges have offered considerable leverage trading.
On Binance, one could leverage up to 125x, whereas on FTX, it’s 101x. So it begs the question, why they have taken this decision. Let’s try to understand that in this piece today.
What is leverage trading?
As the name suggests, traders can leverage their positions by betting more than they own. They can predict that the price of cryptocurrencies will rise or fall in the future, and based on that, they can leverage their current ownership. So if they believe that the price will fall, they can borrow or leverage their position to make a bigger bet.
To explain it better – suppose you have 100 USDT, you can leverage it 10x, which makes it 1000 USDT, and take a bet. So if your prediction is correct, you’ll be able to make 10 times the money you actually had. But, of course, the vice versa is also true, and you can lose 10x the money even if you don’t have it. This is known as Leverage Trading for Crypto.
Is futures trading the reason for Bitcoin crash?
Last week, The New York Times ran an investigative story where it attributed the decline in the price of Bitcoin to leverage trading of premier cryptocurrency. Additionally, it mentions that the price crashed due to the accounts getting liquidated for their positions. Of course, correlation isn’t causation, so this could be one of the reasons, if not the only reason for Bitcoin’s price to reduce by half.
Why have the exchanges reduced it to 20x?
Both FTX and Binance maintain that less than 1% of their users utilize high leverage trading. FTX’s Fried mentioned that most users only use 2x leverage while trading. Yet, both of them have now reduced the maximum trading leverage to 20x.
Binance’s CZ has mentioned that this is “in the interest of Consumer Protection.” On Binance, new users signing up on or after July 19th would only get 20x leverage. This would also apply to all users soon.
Of course, the increasing regulatory action is also another reason. In fact, the NYT mentions that the US government is planning to have some strict regulations around leverage trading, so it’s interesting that these exchanges have already reduced the limit. There are other exchanges such as BitMEX that do offer high leverage trading.
Considering that the price of Bitcoin is now hovering around $40,000 (before reducing to ~$36k), it’s evident that the market is responding positively to this news.
What do you think about this move? Do you like to do leverage trading?