Leverage Strategies and Their Drawbacks
The two dominant leverage strategies in the cryptocurrency market are perpetual futures and spot borrowing. While these methods differ in their mechanics, they share several significant drawbacks.Mechanics
Perpetual Futures (perps)
allow traders to open leveraged long or short positions without an expiry date. In AMM-based perps, traders interact with a liquidity pool, compensating liquidity providers with a funding rate for open positions on the wrong side of the oracle price. In order book-based perps, traders’ orders match against each other while funding rates align prices with the spot market. Both variants require collateral, and traders risk liquidation if the market price slips too far from their prediction.
Spot Leverage
allows a trader to borrow assets against collateral to increase their position size. One strategy may involve borrowing a stablecoin to purchase a volatile asset, hoping to profit from the spread of the asset’s appreciation over a period of time. The trader then sells the volatile asset and uses the proceeds to repay the stablecoin loan with interest.
Drawbacks
High Ongoing Costs
- Perps traders pay an average annualized funding rate of 60% on Jupiter perpetual exchange and similar rates on other exchanges.
- In spot leverage, USDC borrowing rates on lending platforms like Kamino range between 10% to 40%. This means that borrows must generate annualized returns greater than the lending rate to profit.
Liquidation Risk
Both methods expose users to forced position closures (liquidation) in high volatility periods, often leading to significant losses.
Health Management
Traders must either actively monitor their positions’ health ratios or place correctly tuned limits and stop losses to avoid liquidation. This aspect creates stress and complexity for all but the most experienced traders.