Recently, I’ve seen friends asking about how leverage trading actually works, so I went ahead and organized my understanding here, because this involves the liquidation risk that many people are concerned about.

First, let’s talk about the simplest situation. Suppose Bitcoin is $50,000 per coin, and you use $50,000 to buy—that’s regular trading, nothing special. But leverage is different. You only need to put up $5,000. I’ll cover the remaining $45,000 for you—this is ten times leverage. Of course, my money isn’t a gift; you’ll have to pay it back later.

At this point, if the price of Bitcoin rises to $55,000 and you sell, you pay me back the $45,000 and keep a net profit of $10,000. Essentially, your $5,000 principal has doubled—that’s the appeal of leverage. But here’s the problem: what if the price drops to $45,000? Your $5,000 principal is wiped out immediately, while the $45,000 I lent you is still there. You might think the price will bounce back, but I won’t “hold on with you,” because that’s my money. I have the right to sell the coins directly and take my $45,000 back. A worse scenario is if you only sell after the price drops to $44,000—you won’t just lose everything, you’ll also owe me $1,000. This $1,000 is a debt, and you must repay it. This situation is called liquidation.

To avoid liquidation, the only way is to add more margin. For example, add another $5,000 to your account. Then the combined value of your cash and the coins will exceed $45,000 again, and I won’t force-liquidate your position.

With the theory out of the way, now let me tell a real story that actually happened. In China, there used to be a large number of fake commodity exchanges. These exchanges were different from scam websites that fabricate data directly. Their data was all real, but they still managed to trick investors into losing everything.

The method is actually very simple. Suppose they trade a commodity with ten times leverage, and the current price is $50,000 per unit. In the market, there are both long positions and short positions, and everyone holds positions. The exchange controls all investors’ position data, knows their funds and leverage ratios, and even knows when they’re active.

All they need to do is pick a time in the middle of the night, when most people are asleep, and coordinate with a few well-funded market makers. Then the hunt can begin. Why does it have to be at night? Because people who are asleep can’t add margin in time. The market makers go crazy with long positions, pushing the price from $50,000 to $55,000. Those short investors who are fully margined and using ten times leverage immediately cross the line. They’re still asleep, so they can’t add margin at all—so they get automatically liquidated and forced out.

This process doesn’t require much money, because most people are asleep. You only need a small amount of capital to push the price up. The liquidated shorts automatically generate buy orders, which actually helps the market makers keep driving the price higher. As the price continues to rise, investors who only kept a little capital and are using 8x or 9x leverage also start to get liquidated. The market makers only need a small amount of money—like rolling a snowball—sweeping upward, blowing up those using 8x, 7x, and even more conservative leverage.

Suppose the price is pushed from $50,000 up to $75,000—then all short sellers with leverage of 5x or higher get liquidated. Where does the money from these liquidations go? If the market makers are also using ten times leverage, then from $50,000 to $75,000, when they close positions, their pure profit can be four times. Even more impressive: after they finish liquidating the shorts, the market makers can switch to the opposite strategy. Now they start going crazy with short selling, dumping to put downward pressure on the price. Since the move from $50,000 to $75,000 was driven by the market makers themselves, there aren’t many follow-the-leader orders, and leverage shorting can still make money. Dropping the price from $75,000 back to $50,000 isn’t that hard. Then they increase their capital again and repeat the process—pushing it from $50,000 down to $25,000. At this point, investors who went long at $50,000 with 5x leverage or higher get liquidated again. The market makers buy back and close their positions—the harvest is complete.

All the trades are real; there’s no fabrication of data. The market makers only need a larger pool of capital than retail traders, plus access to the specific trading data of retail traders—entry prices, position size, leverage ratios, and when retail traders stop being active. With this inside information, they can carry out precise targeting. Whether retail traders are long or short, they get liquidated, while the market makers profit handsomely.

Of course, the story above isn’t about Bitcoin. That’s only something black-hearted exchanges with no regulation in the community would do. Bitcoin is so legitimate—how could there be market makers? How could 20% of people control 80% of the chips? And since Bitcoin is so secure, how could an exchange manage to trick people for money just by using access to trading data?

So Bitcoin is good, and liquidation is definitely just a normal market occurrence. There’s definitely no scheme behind it.

If you want to go deep in the crypto space but haven’t found your direction yet, you can check out the introduction on my profile page. We can exchange ideas. If there’s a chance, I’ll discuss contract and spot trading layouts with everyone. But don’t come right away asking me which coin I like or how to make money—I honestly don’t know. I hope our meeting can stay the way it was at the beginning.