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Margin Trading Explained
The last few years have seen a seismic shift in the cryptocurrency industry, from up-start, poorly understood technologies to powerhouses of consumer utility and value for investors. The 5 largest players in cryptocurrency, Bitcoin, Ethereum, Ripple, Bitcoin Cash, and Eosio, collectively have a market capitalization of close to $200 billion USD as of the end of June 2018, with growth only poised to increase. Early investors in cryptocurrencies have seen returns on the order of 200,000% or more in just a few short years.
One of the unique features of many cryptocurrencies that set them apart from traditional fiat currencies is the fact that they form a closed system with a finite supply – that is, the number of coins to ever be available in a given currency is fixed. This means as greater adoption of the coin occurs, the demand goes up, and with no corresponding increase in supply, the price of the coin goes up as well.
For investors looking to get involved in the cryptocurrency market, current prices can be a challenge. While fractional trading (up to 8 decimal places in some cases) is certainly possible, looking at whole amounts of coins, especially from major player Bitcoin, can be daunting, with single coin values being in excess of $5,000.
As with any investment, it can be beneficial to utilize margin trading, allowing for greater purchasing flexibility, though with increased risk. In this article, we’ll discuss cryptocurrency margin trading, the advantages, and benefits it provides, and look at some of the crypto exchanges that currently offer margin trading.
What is Margin Trading?
Margin trading, in general terms, refers to trading an investment instrument with borrowed funds, typically from a broker. While regulations differ depending on jurisdiction and what type of investment is being traded, traditional margin trading in the stock market involves a consumer depositing money in a special margin account, then making a purchase of a stock on margin, where up to half of the cost of the purchase can be paid for on margin, that is with loaned funds from the brokerage. This is usually done for short-term trading, as like with any loan, interest accrues over time, meaning an investor needs to get a bigger and bigger return on the investment in order to break even or see any profit.
This is, essentially, utilizing the concept of leverage – that is, amplifying your buying power through debt. It allows investors to trade significantly greater quantities of shares of stock, commodities, or whatever else they are trading, increasing profit potential, but also increases risk. The same holds true in cryptocurrency margin trading.
What Does Margin Trading Have to Do with Cryptocurrencies?
With cryptocurrency margin trading, the same concepts as traditional margin trading apply. The key difference is instead of purchasing shares of stock or a commodity, the investment instrument is a purchase of cryptocoins. In most cases, various exchanges themselves can provide margin trading functions, lending coins to users in exchange for interest. In some cases, other users can also lend their coins out, directly benefitting themselves from the interest.
Some of the other key terms that are relevant to margin trading in general, as well as cryptocurrency margin trading, include:
- Leverage – in addition to the definition provided above, this quality can usually be summarized as a ration, i.e., 2:1 leverage means that if you purchased $100 of an investment with your funds, an additional $100 was purchased with lent funds.
- Liquidation value – the point at which the lender, brokerage, or exchange will automatically close the account and liquidate the investor’s position, to ensure the lender gets all of their initial capital and interest back, and the investor loses only, at most, their original investment plus interest and fee payments.
- Long – a trade position that is a “bet” that the value of an investment is going to go up.
- Short – a trade position that is a “bet” that the value of an investment is going to go down.
Is Margin Trading Safe?
Margin trading, in stocks or cryptocurrency, is “safe” in terms of security, but extremely risky in terms of investment. There is a great potential for rewards, as leverage can effectively double any potential gains made on an investment. At the same time, the risk is much higher, in addition to losing your own investment capital, you have the interest and fees from the lender on top of that.
The risk is compounded when it comes to crypto margin trading. This is due to the fact that cryptocurrencies are already extremely volatile assets to trade, with wild shifts in their value that can happen quite rapidly. This is in contrast to traditional stock investments, where, absent a massive market crash, most stock values do not shift more than 10-20% of their value, at most, in a given trading session. Therefore, it is very possible to quickly run into liquidation value and trigger a sell-off of your crypto assets, much more so than in traditional margin trading.
In general, margin trading, including cryptocurrency margin trading, is not for the faint of heart. Investors need to be extremely disciplined as to their stop loss or sell-off points, what assets they invest in, and how quickly they react to changes in the market. They also need to be prepared to lose all their invested funds, plus the additional interest and fees, which can typically be up to 50% of the lent funds depending on how long the investment was held. This is in contrast to a regular (cash) investment, where the maximum financial risk is the initial investment amount only.
Therefore, cryptocurrency margin trading especially can be quite stressful and require a good deal of management, attention, and expertise. It is best suited for short-term, day-trading style investments, in order to minimize the interest charges and help protect against hitting the liquidation value of a given investment.
Advantages of Margin Trading
Margin trading is certainly risky, but that risk is also one of the reasons that it has great appeal. As with most investments, and most things in life, great risk can bring great reward. At its core, margin trading helps amplify investment gains, by allowing for up to double the purchased amount of shares, coins, or other denomination of assets than the investor would otherwise be able to purchase with their own funds. This of course also means the risk of losses, and amount of loss is also amplified.
This can best be demonstrated with an example. Suppose John wants to invest in Bitcoin. For the sake of keeping the math simple, let’s assume a single Bitcoin is currently trading at $1,000. John has $5,000 to invest.
- Scenario A: If John buys on a cash basis, he can purchase 5 Bitcoins.
- Scenario B: If he buys on margin, he can purchase 5 Bitcoins on his own, and 5 additional Bitcoins from the leveraged funds.
- Now suppose the value of Bitcoin a day later is $1,200, and John wants to sell to make a quick buck.
- Scenario A: John sells his coins, for a $1,000 profit (5 x ($1,200 – $1,000)).
- Scenario B: John sells his coins, for a gross profit of $2,000 (10 x ($1,200 – $1,000)). The lender is paid back their principal, and John is required to pay interest for the day he used the loaned money, as well as the initial fees for setting up a margin account. In this case, because he held the investment for a very short time, he only owes 0.05% interest and $10 in fees, which equates to $12.50 ($5,000 x 0.05% = $2.50 + $10 = $12.50)
This worked out well for John, as he ended up with $1,987.50 from the margin trade, vs. only $1,000 from his cash trade. But let’s look at another example. Let’s say he held the coins for 30 days, and the value decreased to $800, and now he wants to get out of this investment before it goes any lower.
- Scenario A: John sells his coins, for a loss of $1,000 (5 x ($800 – $1,000))
- Scenario B: John sells his coins, for a gross loss of $2,000 (10 x ($800 – $1,000). He had to pay all of the loaned capital back, so the $2,000 gross loss is entirely his. Further, he needs to pay the $10 fee on the account, as well as 30 days of 0.05% compounded interest on the loan. The fee amounts to only $10, so he’s now only $2,010 in the hole. The interest, however, adds up to $75 (we’ll keep it simple and avoid compounding for now), meaning his total loss is $2,085, more than double his cash trade in Scenario A.
The exact interest rate and fees charged, as well as how often they compound, can be key considerations in choosing which exchange, brokerage, or other lenders for opening a margin account, and should be reviewed carefully to compare apples-to-apples, to avoid paying more fees and interest than necessary.
Crypto Exchanges Offering Margin Trading
Many cryptocurrency exchanges offer margin trading, either directly from the managing agency or company, or through users offering their own coins as margin funds (and therefore reaping the rewards of interest). In most cases, these are relatively safe and secure means of cryptocurrency margin trading. However, as with all online and networked investments, there is always the potential for hacks that can cause data (and financial) loss, much more than in traditional stock investments with reputable brokerages.
Therefore, users who wish to engage in crypto margin trading should use a moderate amount of caution, as the marketplace is relatively new, hacks have happened in the past, and the volatility is already significant compared to traditional investment instruments.
Some of the popular exchanges that offer margin trading, and details about their offerings, include:
One of the largest trading exchanges in the cryptocurrency world. Allows users to trade on up to 3.3x leverage, that can either automatically be booked by the exchange when requested, or can be individually shopped for among the P2P margin funding network the exchange supports. They boast a typical daily trading volume of $300-500m USD.
One of the most popular cryptocurrency margin trading exchanges, with a good reputation among users. They offer up to 100x leverage for margin trading of Bitcoin, and 20-50x on many other cryptocurrencies. They have a comprehensive set of guides and FAQs on their platform specifically geared toward margin trading, and offer a number of valuable types of orders and controls to help margin traders thrive. It has a daily volume of trades in excess of $2B USD in Bitcoin alone, not including the other currencies on the exchange.
A highly versatile and reliable cryptocurrency exchange, offering compatibility with SWIFT and SEPA bank accounts, registered in the UK and stated with FinCEN. Much smaller than some other players though. 2:1 and 3:1 leverage available on Bitcoin and Ethereum. Automatic margin funding at the time the order is placed. No separate margin accounts needed.
Huobi Pro offers a huge number of cryptocurrencies on its exchange, with volumes and dollar equivalents ranging from very small to very large (for example, Bitcoin to USD tether on any given day alone might be $50-100M). Has a comprehensive margin trading system, allowing users to both trades on margin and lend their assets as margin to other investors. Very reasonable rates of 0.02% daily interest on most of the marginal securities on their exchange. It should be noted that Huobi is not currently available for US users, though a US partner exchange is coming soon.
- Kraken was founded in 2011 and has grown to be one of the most trusted cryptocurrency exchanges available today. They offer a number of different coins on the exchange. Not all coins can be traded on margin, but those that can offer 2-5x leverage. Interest rates tend to be a bit higher here, compounding every 4 hours in most cases rather than daily. The exchange loans funds for margin trading directly, and it does not use a P2P or user-based loan model.
In summary, cryptocurrency margin trading has a great potential upside for investors, amplifying their potential gains significantly. However, the downside is also quite large, especially for longer-term investments, as interest and fees can accumulate rapidly. Margin trading is tantalizing for many investors, but should not be undertaken lightly – in the crypto world or the world of more traditional investments.
It is advised that those considering crypto margin trading read and research significantly before making an investment decision and then do so only with money they can fully afford to lose. A good rule of thumb is to make sure that you are prepared to lose all of your initial investment, plus 50%, for any investments that are longer than a few days in length. If you do choose to go down this path, be sure to compare exchanges and options to ensure you get the best interest rate and lowest fees.
Please browse through the rest of our site for more information on exchanges and currencies. We wish you the best of luck!