Cryptocurrency has taken the world by storm and, in many ways, seems to expand into more and more areas of contemporary culture. One of those realms that crypto has touched is trading, and it seems that within only a couple of years, so much has happened in the Web 3.0 trading world.
Not only are cryptocurrencies being traded in their standard forms through the many exchanges popping up left and right, but these exchanges and various surrounding services have been offering other derivative financial instruments and facilities that borrow from the traditional trading world.
Many things have come into the crypto trading world from the traditional trading world that allows investors to make wise choices and optimize their earnings, and one of those things that have come into the crypto trading world is margin trading.
Crypto Margin Trading for Beginners
Margin trading is leveraged trading that gives you the buying power to trade with more capital than you have at hand. More specifically, margin trading is a type of leveraged trading that allows you to lend from your trading platform or brokerage immediately.
Margin Trading in the Traditional Markets
In the traditional stock, derivatives, and foreign exchange markets, margin trading is a common way to use borrowed capital to trade in the market.
Margin trading gets facilitated by the brokerage or trading platform. It is a loan that gets immediately administered by the brokerage so that you can multiply your total investment in mere seconds with a click of a button.
Initial Margins
The margin you can borrow from the institution of your choice depends on the initial margin you have in your account when you want to trade.
The “initial margin” is the amount of equity capital you need to have for yourself before you can trade on the margin. With each set amount you want to trade on the margin, there is a respective amount of capital you need to already have on your account at the time of your trade.
Once you have the proper initial margin on your account, what margin trading does is that it allows the investor to trade multiples of their deposited capital so that when the opportunity strikes, the investor can make a more significant profit.
Why Is Margin Trading Popular?
As you might expect, this potential to make money without having the cash at hand makes margin trading especially attractive.
Even though you may only have very little liquid money, you may be able to invest multiple folds of the cash you have at hand. Your ability to trade is enhanced, allowing you access to opportunities that would’ve otherwise been too expensive or risky.
For example, instead of being limited to merely investing USD 1,000 on an investment that the trader is confident in, if the required initial margin is one percent, holding a margin position allows the investor to trade an additional $100,000. Investors only have to take out a loan directly from the brokerage (usually, you can only find such significant rates in particular markets, like the foreign exchange market).
With such a significant increase in the amount and accessibility of capital, it makes sense that this leverage trading option is an essential tool in the arsenal of the apt trader.
If an investor is sure of the upward movement of their investments, it is a great option to optimize and increase the resultant profit. If the stock moves up two percent, in the example we used above, the investor makes not $2 but 200 dollars off their investment. That is a 10,000% increase in the total profit they can drive.
Margin Trading and Debt
Of course, as with any loan from regular trading, debt incurred from Bitcoin margin trading will have an interest attached, along with trading fees. Whether or not you profit, you will have to pay off your loans.
This means that you have to read the fine print on the brokerage’s offering of the margin and think about the impact the interest will have on the trade profits.
It may be the case that your interest might overwhelm and negate any of the profit you make if you do not make sure to account for the interest.
Interest (as in any trading circumstances) must be considered when trading on the margin.
Margin Trading in the Crypto Market
Much of what is the case in margin trading in the traditional markets carries over directly into the crypto market.
How Crypto Margin Trading Is Similar to Traditional Margin Trading
As in traditional markets, the brokerages and trading platforms allow the investor to trade with more capital than their account contains as long as their account meets the initial margin.
In the case of cryptocurrency, similar to the stock market, rather than, say, the foreign exchange market, usually the margin is given when buying the asset itself.
That is, margin trading is active from the dollar side of the equation. So, the margin offered depends on the amount of capital in dollars you have invested into your trading account.
Many crypto trading exchanges offer margin trading, and some even offer up to five times the leverage on their account equity capital.
So essentially, instead of borrowing capital to purchase stocks or other derivatives, in crypto trading, you would be borrowing capital (whether it be dollars or other national currencies) to buy cryptocurrencies of your choice.
How Crypto Margins Are Similar to Foreign Exchange Margins
On the other hand, however, there may be some similarities that cryptocurrency margin trading might have with foreign exchange market margin trading simply because both are some forms of currency. This may be true regarding the underlying movers that allow one currency to be valued higher than the other.
We understand global currency valuation — the US dollar may rise in value relative to the British pound because of the general expectation and anticipation of the movement of the American economy over the British economy. Of course, because crypto functions as a currency, it has a similar relationship to currency markets.
For example, one cryptocurrency, say Bitcoin (BTC) or Ethereum (ETH), might rise in value over the Venezuelan bolivar because of the considerations of the Venezuelan economy and stability over that of the coin’s stability on a crypto exchange like Binance, BitMEX, Kraken, PrimeXBT, or ByBit.
Such a fluctuation was seen in the real world when the Venezuelan bolivar dropped in value like a boulder compared to Bitcoin. Bitcoin helped to make the economy still possible in Venezuela. Yes, there are cases when the Bitcoin market moves with more stability than a national currency.
However, the foreign exchange and crypto markets begin to diverge (at least when it comes to margin trading) when we realize that we can’t do the same with cryptocurrency as we do with national currencies. That is, crypto traders can’t trade the crypto asset on the margin like we would with the national currencies.
Crypto Margin Trading Today
Even now, cryptocurrency is traded like a non-currency asset rather than a currency.
At least in most exchanges, it is not possible to trade Bitcoin on the margin. We can’t take our account of one Bitcoin and leverage it to trade with two Bitcoins to purchase more Ethereum or perhaps even another currency.
Instead, Bitcoin or Ethereum is traded like a commodity or a stock rather than a currency.
Risk Management with Margin Trading
In general, margin trading with digital assets like crypto is high-risk because, in most cases, you can lose a lot more money than if you had not used margin trading. On top of that, if you’re not careful, you could lose more money than you had in your account.
What Happens When You Lose Money When Margin Trading?
To explain, in most cases, because you are leveraged and therefore trading with borrowed money, whatever loss you make with your borrowed capital is essentially an additional loss to the capital you possess.
For example, if a margin trader has $1,000 in your accounts and starts trading on a margin with an additional $1,000, whatever losses they have will essentially be doubled (that is, if they decide to trade all the capital you now have at their disposal). That means they’re now borrowing funds.
You can lose a lot more money very quickly due to market volatility and changing interest rates, especially because now you have to pay back the losses to lenders in addition to the interest, in addition to the actual loan itself. These factors make margin trading even on cryptocurrency markets even more high-risk.
In the worst circumstances, you may lose your entire capital due to significant price movements and lose a loss equal to or even more than the total capital you initially deposited into your investment account.
What Is a Margin Call?
To make matters more severe, another thing to keep in mind is that there is something called a margin call. A margin call is a phenomenon that occurs at a specific floor value that your total investment account cannot fall below.
For example, you might have been trading on a margin, and the floor may have been determined at $1,000. In such a case, if the total market value of your investments falls below $1,000, the margin call will be triggered, and you will have to deposit more equity into your account by adding more assets or liquid capital into your trading account.
In some cases, if the margin call is executed, you might have to deposit more of the capital you do not have just to maintain your account.
Another option to merely depositing more capital into your account is to sell some of your assets — a move that you might be very wary of making, especially since you will be losing a lot of money in such a situation.
Final Thoughts
Trading on the margin is a trading strategy and facility that has been around for a long time in traditional markets.
In the case of Web 3.0, trading on the margin introduces many benefits that can help increase profits and maximize returns.
If the investor is sure about his moves and is willing to take a little risk, margin trading might present a quick way to increase his returns.
However, as with all investment decisions, consider the risks before you decide on margin trading.
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Sources:
Initial Margin: Definition, Minimum Requirements, Example | Investopedia
Forex Leverage: A Double-Edged Sword | Investopedia
How are the interest charges calculated on my margin account? | Investopedia
Margin Trading Crypto: What It Is & How It Works | SoFi
Margin Trading Cryptocurrency | Leverage Your Trades Up To 5x | Kraken
As Venezuela’s economy regresses, crypto fills the gaps | Reuters
Margin Call: What It Is and How to Meet One with Examples | Investopedia
