Margin trading in cryptocurrency means buying digital assets with more than the sum of coins or tokens that you have, just like you can do with stocks. This is possible thanks to the lending market known as leverage, which also works for cryptocurrencies.
As a trader, you can make more profit from your investments by borrowing against your current funds. For instance, say you decide to invest $250 and borrow $750 to buy $1,000 worth of BTC. This is a leverage of 4:1. In this case, the initial margin is worth $250, as this is the cash you need to deposit to purchase digital assets on margin.
Margin trading enables you to open a position with leverage, as you increase your buying power. At the same time, lenders benefit from interest on the loans. When trying to make money trading cryptocurrency, this can help you to increase profits.
Providing you make smart choices, it’s a win-win situation. But, for as lucrative as it may seem, margin trading can also go wrong. Remember that no matter what happens, you’ll have to give back the $750 borrowed plus fees and interest.
Since this ecosystem is risky due to the high volatility of cryptocurrencies and hard-to-predict market movements, margin trading in cryptocurrency is like adding risk to risk.
What is a margin call?
Many exchanges have maximum leverage in place as a measure to protect the lender’s money. Also called the maintenance margin, it makes sure that the value of the digital assets in the margin account doesn’t go below a certain point.
Going back to the previous example, let’s say you put down $250 and borrowed $750. Calculating possible fees, when you start betting, you can only lose a little under $250 of the total $1,000.
If prices go up, you can keep your position open for as long as you like, since there’s no risk of losing the lender’s money or assets. However, if prices go down, you risk having your position liquidated based on the leverage rate.
When you risk losing the lender’s money, the exchange will “call in” your margin trade to prevent you from losing money you don’t own. You can stop this either by selling some of the assets or putting down more funds.
Selling regardless of price may not seem like the best idea. However, the second of the above options is what makes most people in margin trading hit bottom.
Putting more money down to avoid the margin call can quickly turn into a sinkhole for traders, who can end up losing all their digital assets.
Pros and cons of margin trading in cryptocurrency
There’s a lot of controversy around margin trading and how risky it can be even for experienced traders. However, it has several advantages:
- High return on investment: When you take advantage of leverage, your return is X times larger than if you were only using your money (replace X with the leverage level).
- Flexibility: You can benefit from timely market opportunities even when you have little cash available.
- Diversification: Margin trading gives you more investing power, which means you can invest in BTC and multiple altcoins with a limited amount of money.
These advantages also come with high risks and several drawbacks:
- Possible large losses: Leverage can increase returns, but it can also magnify losses. Without a highly-efficient risk management structure in place, you can lose all your capital quickly.
- Costs: Due to minimum margins, even a small move in the opposite direction can cause your position to be called in or closed. However, you continue to pay interest for the blocked money or assets since they’re borrowed. If this situation occurs for too long, the interest will reduce your profits significantly.
- Stress: Cryptocurrency trading is stressful when you trade with your own money. Imagine how it is when you operate with digital assets and funds that don’t belong to you! You need a cool head and in-depth knowledge of the market to make money out of margin trading.
The takeaway
Margin trading in cryptocurrency isn’t something you can start doing overnight. A trader should carry out extensive research about the market and digital assets before betting with borrowed money.
The advantages are obvious, but so are the risks – for margin trading in general, and especially in cryptocurrency, where winning and losing are more frequent and fast than on the stock market.
Disclaimer: The views and opinions expressed by the author should not be considered as financial advice. We do not give advice on financial products.