Trading cryptocurrency on margin has its perks, however, there are also risks involved. With this brief guide, you will be introduced to the basics of cryptocurrency margin trade and get an idea of isolated margin and cross-margin in trade.
What does it mean to margin trade cryptocurrency?
Margin trading in cryptocurrencies is a variety of trades where an investor utilizes leveraged money to open positions for a rise or fall in the price of digital assets.
This approach can significantly maximize both returns due to leverage and losses.
Mechanism of margin trading in cryptocurrency
It is easiest for beginners to understand this type of trading with an example. A trader is optimistic about Bitcoin’s growth prospects: he is confident that the price will rise by 10%. The trader buys a portion of BTC to wait for the price to rise and sell, but only $100 is available for investment. Thus, by buying a part of the coin, he makes a profit of $10.
However, with the help of cryptocurrency margin trading, it is possible to increase the size of the profit. In addition to his $100, a trader can borrow $1,000: if the price of Bitcoin is predicted to rise by 10%, he will receive a profit of $100. This is the simplest statement of the margin trading model, but there are nuances that make the mechanism quite complex.
Short-term and long-term orders
When margin trade, you can open long or short orders, betting on prices rising or falling respectively:
Short-term position. A bet on cost down. The investor loans the cryptocurrency, sells it at the present value, and then buys it out at a lower cost to make up the difference.
Long-term position. A wager on cost growth. A trader borrows money, buys coins at the flowing cost, and then sells at a higher price.
When opening a position, you can set the amount of leverage: 1x, 2x, 3x, etc. Often leakage is stated in such proportions as 100:1. To open a position, you must have or add to your account funds equal to the margin required to meet this ratio, commonly referred to as leverage.
Margin layers, margin calls and liquidations
There are a lot of professional terms to be aware of:
Initial margin is the deposit you make to start a session.
Margin layer is the sum of money that the exchange or platform requires to be held in the trader’s margin deposit account.
Supporting margin is whatever collateral needs to be added to support a transaction. For e.g. if you have entered a short session and the cost has risen, the margin requirement will be changed and you may have a margin requirement.
Marginal requirement is a notice given by a stock market or trading platform that the margin level is low and needs to add funds to avoid elimination.
Also, there is such a thing as liquidation, meaning the forceful disposal of pledged collateral to cover losses. Since this process is usually carried out by crypto exchanges in an automated manner, it is otherwise referred to as involuntary liquidation.
What constitutes isolated margin and cross-margin?
Anyone involved in margin crypto trading is confronted with the concepts of «isolated margin trading» and «cross-margin trading». Now let’s get to the meaning of them.
Isolated margin refers to the collateral for a particular open position. A deficit of funds on one position or its liquidation doesn’t affect the other open positions of the trader.
Cross-margin represents the total collateral balance for several open positions. Possible deficit on one of positions is compensated by profit on other open positions.
Some platforms provide cross margin service. It enables investors to maintain the necessary level of margin by closing the lack of funds on one trade with the profit from the reverse position. For e.g., you can take a long-term and a short-term trading stance and manage the total margin due to mutual compensation.
Strengths and weaknesses of margin trading in cryptocurrencies
The main advantage of margin trading is the possibility to increase profits due to leverage. An investor can open larger deals with less capital. However, there are also risks. Margin trading is the opportunity to increase profits due to leverage. An investor can open larger trades with lower equity. However, there are risks.
Let’s look at an example. You loaned $1,000 with only $100 in collateral. Then you took a long-term position in Bitcoins, however, the cost dropped by 10% and you missed out on $100. Now you either need to close the position or add funds to your collateral to support margin calls.
The crypto market is a highly voluntary place. In a day or even an hour, costs can significantly shift. Hence, margin trading is regarded as a highly risky type of investment.
What fees are charged for cryptocurrency margin trading?
Commissions for crypto margin trading vary from marketplace to marketplace, but most exchanges provide flat commissions based on margin paired trading. These commissions are usually a low percent, i.e. 0.01% or 0.02%. Typically, the trader pays them when opening a position and also every day as an annual fee as an ongoing rate of interest on loaned capital until the position is closed.
