What Is Leverage in Crypto? Types, Risks, and How to Use It Without Getting Rekt

Ok, real talk, people are way too scared of leverage.

Sure, you can get REKT from it, but there are different types of leverage and better and worse ways to use them.

Not to mention, nearly every single rich person in the world is using it in one form or another.

To understand what I am talking about, let’s first define leverage.

What is Leverage?

Leverage is a financial term used to describe the use of borrowed funds or debt to increase the potential return on an investment or to amplify the impact of a financial transaction. 

It involves using a relatively small amount of capital (your own money) and borrowing a larger amount of money to make an investment or engage in a business activity. 

The goal of leverage is to magnify gains if the investment performs well.

Leverage can be applied in various ways, including:

• Financial Leverage: This involves borrowing money, often through loans or issuing bonds, to invest in assets or projects that have the potential to generate higher returns than the cost of borrowing. If the return on investment exceeds the interest and other costs of borrowing, it can lead to increased profits for the investor.
• Operational Leverage: Operational leverage refers to the use of fixed costs in a company’s operations. When a company has high fixed costs, it means that a significant portion of its expenses doesn’t change with changes in production or sales volume. If the company can increase its sales or production, it can enjoy greater profits due to the leverage of those fixed costs.
• Leveraged Investments: Some financial products and investment strategies allow individuals and institutions to magnify their exposure to the financial markets. For example, trading on margin allows investors to borrow funds to buy more securities than they could with their own capital. While this can lead to higher potential returns, it also comes with higher risk, as losses can be magnified as well.

Leverage at a Glance: Which Type Fits Your Strategy?

👉 Quick takeaway: Not all leverage is equal. Mortgage leverage on stable assets is the most forgiving. Leveraged trading on a CEX carries the highest liquidation risk. DeFi vaults like Liquid Loans offer a middle path: borrow against collateral with no interest rate, but liquidation risk applies if your collateral ratio falls below 110%.

How to Choose:

• Low risk tolerance + want yield: Stability Pool strategy (collateral ratio 200-250%)
• Medium risk tolerance + bullish on PLS: Loop strategy at 200% collateral ratio
• High risk tolerance + experienced: Loop strategy approaching 110-150% (not advisable for most)
• Outside DeFi: Real estate mortgage leverage for stable, long-term wealth building

Real Estate Investors Use Leverage

Real estate investors use leverage by borrowing money to finance the purchase of properties. This allows them to control more real estate with a relatively smaller amount of their own capital.

A quick example: With $50,000 in cash and a standard 20% down payment mortgage, a real estate investor can purchase a $250,000 property. If that property appreciates 10% to $275,000, the investor’s $50,000 has effectively grown to $75,000 — a 50% return on their actual capital, not the 10% the property gained. This is the core power of financial leverage applied to hard assets.

The same math applies in DeFi vaults: your capital controls more than it would unleveraged, amplifying both gains and losses proportionally.

Bitcoin and Altcoins as Leverage: What the Cycle Data Shows

Here is how the cycle math typically plays out:

• Bitcoin vs. S&P 500: In major bull cycles, Bitcoin has historically delivered 5x to 20x the returns of the S&P 500 over the same period. In bear cycles, drawdowns of 70-80% are common versus 20-35% for equities.
• Altcoins vs. Bitcoin: High-conviction altcoins (like ETH or LOAN) can outperform Bitcoin by 2x to 10x during peak bull momentum. The inverse is also true: altcoin bear markets are typically more severe.
• The leverage ratio analogy: Holding Bitcoin instead of the S&P 500 is roughly equivalent to holding a 3-5x leveraged equity position — with the key difference that there is no liquidation price and no borrowed capital at risk.

Bottom line on crypto leverage: The leverage is in the volatility itself. You are not borrowing — you are accepting higher variance in exchange for higher potential return. This is why position sizing matters as much as asset selection.

*Note: Past performance does not guarantee future results. Crypto markets are highly volatile.

Bad Ways to Use Leverage

There are many ways to use leverage to your advantage, but there are also ways to use leverage to your disadvantage.

Magnifying the Houses Advantage Against You. Centralized exchange leverage is structurally asymmetric. Here is what that looks like with real numbers:

• You deposit $2,000 as collateral and take 5x leverage: you control a $10,000 position
• If the trade gains 20%, your profit is $2,000 (100% return on your collateral) — the exchange profits from fees and spread
• If the trade loses 20%, your $2,000 collateral is wiped out (100% loss) — the exchange loses nothing
• If the trade loses just 10%, many exchanges liquidate your position before you can react

The Liquidation Trap

With CEX margin trading:

• You put up $5,000 to control $10,000 in stock
• A 50% adverse move liquidates your entire $5,000 collateral
• You exit with zero

With Liquid Loans:

• If your vault is liquidated, you still keep your USDL
• Your loss is capped at your ETH collateral, not your entire position
• This is a structurally different risk profile

The key distinction: CEX leverage punishes you twice — with the loss and with the liquidation. DeFi vault leverage (done responsibly) separates your stablecoin from your collateral risk.

How To Best Leverage Liquid Loans

There are two ways to leverage Liquid Loans in a fairly responsible manner.

The first way is to use the minted USDL to earn yield. The safest way to do this is via the Stability Pool. Stability Providers earn yield in both ETH or PLS and LOAN token in the Stability Pool and they can withdraw their USDL at any time to pay back their debt. 

This leaves their chances of liquidation very low if they are attentive to price fluctuations in ETH and PLS. And even if they are liquidated, it is not a full liquidation because they keep their USDL.

Collateral Ratio Scenarios: What Happens to Your $10,000

Your collateral ratio is the most important number you control. Here is what different ratios mean in practice:

👉 Quick takeaway: The 110% minimum collateral ratio leaves almost no buffer — any meaningful ETH price drop triggers liquidation. Most users should target 200%+ to absorb volatility. 250%+ is the recommended starting point for anyone who cannot monitor their vault daily.

Recommended starting point: 200-250% collateral ratio. This gives you a meaningful safety buffer against ETH price swings while still allowing you to mint and deploy USDL in the Stability Pool for yield.

Formula: Collateral Ratio = (ETH Value / USDL Minted) x 100

Example: $20,000 ETH / $10,000 USDL = 200% collateral ratio. ETH must drop to $10,000 in value before liquidation risk becomes critical.

The Bottom Line: Your Leverage Decision Framework

Leverage is not inherently dangerous. Unmanaged leverage is.

Research tracking organizations that act decisively on structured leverage strategies shows materially superior outcomes versus those who avoid leverage entirely or use it without guardrails. The same principle applies in DeFi: the difference between building wealth and losing your collateral is almost always process, not luck.

Your 3-step leverage checklist before you mint:

1. Set your collateral ratio target first. Never start below 200% unless you are an experienced DeFi user who monitors positions daily. 250% is the recommended floor for most.
2. Choose your yield strategy. Stability Pool first (lower risk, passive yield in ETH and LOAN). Loop strategy second (higher risk, higher ETH exposure).
3. Know your liquidation price before you mint. Use the formula: Liquidation ETH Price = (USDL Debt x 1.10) / ETH Amount. Write this number down and set a price alert.

Leverage used with a plan is a wealth-building tool. Leverage used without one is a fast path to zero.

*Nothing in this article is financial advice. All content is for educational purposes only.