What Is Margin Trading in Crypto and How Does It Work?

Ever noticed a great opportunity during a crypto trade, like the surge spree on Dogecoin back in 2020, and wished you had more money in your position to execute said trade to make an even greater profit?

What Is Margin Trading in Crypto and How Does It Work?

Disclaimer: This is for informational purposes and is not meant to serve as financial or investing advice.

Well, margin trading can allow for just that.

What Is Margin Trading in Crypto?

Margin trading in crypto is also known as “leverage” trading. It allows cryptocurrency traders to magnify their gains and losses on bets made on the crypto market by using borrowed money when making bets on futures or swaps.

When we say borrowed money, an exchange platform, like Binance Futures or ByBit, is loaning you funds to amplify your trading position. You can think of this as “leveraging up” on trades that exceed your initial capital investment.

How Does Margin Trading Work in Crypto?

Great question. Let’s give an example of what we mean.

Let’s say that you have an account with a trading exchange, like BitMEX, and you have $200 of your own money sitting in that account, ready to use. Of course, regardless of your chosen trading platform, your money will be in cryptos — such as Bitcoin (BTC), Ethereum (ETH), or Tether (USDT).

If you used that money to make a trade, yes, you would make a profit, but it would probably be on the smaller side.

Now don’t get us wrong. Small profits are still gains at the end of the day, and they are also an effective method for minimizing risks, such as margin calls, liquidation, or losses of large profits.

But what if the opposite can happen, and you can invest vast amounts of money and make massive profits, all without having to use your funds?

We are here to ensure that it is possible to make more significant profits on the same trade, and you will need to amplify your position with more money. This is where you can trade on margin with borrowed funds from the exchange platform.

So, now your $200, which is your margin, or collateral, is the starting point of loan determination, and if you can borrow 10x that amount, you will then have $2,000 of leverage to trade with and, in turn, provide more sizable gains.

Some margin trading jargon worth noting is the ratio system, long positions, and short positions.

For ratios, they can be expressed, such as 20:1 or 100:1, where the first number consists of the amount you are multiplying your collateral on, which is the correct number. So 10:1 would be 10x your initial position, the same for 100:1, where a platform will loan you 100x your initial position.

For long and short positions, going long means that you believe or are betting that asset prices will go up and you will potentially profit from the move. Going short means that you are betting the asset price will go down, and if you are right, you will also make a profit.

We should add that the margin trading strategy can be extremely risky if you do not fully understand how it works and all the potential outcomes involved.

What Is Liquidation?

A critical factor to keep in mind when using the margin trading method is liquidation or the liquidation price. Due to the extreme volatility of the cryptocurrency markets, leveraged trading provides even more risk.

Liquidation occurs when a trader cannot meet the margin requirement for their leveraged position and is forced into a position closing due to a total margin loss. In other words, you now have insufficient funds to keep your trade open and potentially lose all of your collateral.

This can happen when there is a change in exchange price, and an investor is forced to sell off their crypto assets in exchange for cash, for example, in a market crash or a sudden drop in the underlying asset price.

Ultimately the severity of this loss heavily depends on the initial margin and how much the asset price has dropped. Most crypto exchanges also charge a liquidation fee, and can vary between platforms.

Either partial liquidation or total liquidation can be categorized as liquidation.

Partial liquidation is a safety measure that closes a position partially early to reduce the loss.

Total liquidation occurs when all of the initial margins are gone. This is the worst-case scenario, and you want to avoid this at all costs.

How Can You Start Margin Trading Crypto?

Before starting margin trading crypto, you must choose a platform. Several crypto exchanges allow traders to use margin trading to their advantage. To date, these exchanges include:

  1. ApolloX
  2. BitMEX
  3. Binance Futures
  4. ByBit
  5. Delta Exchange
  6. Huobi Futures
  7. KuCoin Futures
  8. Phemex
  9. PrimeXBT

These exchanges offer leverage anywhere from 10x to 125x.

It is also important to note that many cryptocurrency exchanges can charge fees to use these services. Usually, two costs are associated with margin trading:

  1. Fees for opening a position
  2. Interest owed for borrowing tokens or coins

The interest depends on a few factors, such as the current premium between your spot and the asset's futures price, and is calculated every hour.

What Are the Benefits of Crypto Margin Trading?

There are abundant benefits to crypto margin trading:

1. Large Short-Term Profits

One of the most attractive benefits of margin trading in crypto is the huge profits you can gain quickly. This is due to being able to trade with high amounts of money and with the power of compounding, making it apparent to see massive gains.

2. Less Capital Needed for Large Positions

Since your initial investment, your margin is the starting point for the crypto exchange to determine how much money they will loan you; you do not need as much capital upfront.

With margin trading, you can quickly increase your buying power and take a more prominent position on trade. This is especially beneficial because you do not have to cough up much of your money.

4. Diversify Your Portfolio

With leveraged funds, a seasoned investor can make profits not only on bets on one asset but many different assets. It is essential to diversify your portfolio to reduce risks, but it is much easier if you have enough money in your account.

What Are the Risks of Crypto Margin Trading?

Just as margin trading provides many benefits to an investor, it is a double-edged sword with an equal amount of risks.

1. Higher Potential Losses

As there is great potential to make a load of gains with margin trading, just the same, there is a higher potential to see significant losses.

If you do not have the proper risk management techniques in place, you can quickly deplete the amount of capital you have.

2. Requires Excellent Timing

One of the reasons that margin trading is not for the crypto newbie is that it takes experience and skill to time out a trade perfectly.

Knowing the perfect time to execute a trade can be very tricky since the crypto market is highly volatile, fluctuating every second.

Crypto traders know that the crypto market moves in less predictable ways than traditional markets. Digital assets experience fluctuations and price movements much more extreme than conventional assets, making cryptocurrency margin trading a little more complex.

3. Risk of Margin Calls

A margin call occurs when there is an opposite move against the trader's bet, which causes significant drops in their account balance. This is a warning from the exchange platform that you are nearing low on funds and need to either close out a position or bring margin deposits back up.

Margin calls usually happen before liquidation occurs and be happy that they do!

4. Owing Interest

Since you are borrowing funds to make trade profits, fees or repayments are involved. When an exchange platform provides leverage, they also expect earnings.

When you make a profit, interest is charged on that profit you owe to your lender. This can be considered a rollover rate that is applied to your position.

Risk Management When Margin Trading in Crypto

Every seasoned crypto investor or margin trader can attest that implementing risk management strategies when margin trading is imperative to being successful. Crypto can be even more high-risk than margin accounts in the traditional stock market, making risk management all the more essential.

Even though margin trading has its appeal, you must familiarize yourself with some sort of risk management, including:

  • Keep a separate trading account for margin trading in which you allocate only a certain amount of funds for capital.
  • Use a stop-loss: With this tool, you can set a price level that you want the exchange to close out a position for you if reached. This tool enables you to cut losses and eliminates liquidation.
  • Take your profits: This means that you may have the potential to make MORE profits, but by closing out at a profit, you are satisfied with curbing the volatility factor in the crypto market.
  • Do not “revenge trade”: When you lose money in the crypto market, it can be tempting to try and make it back up immediately in one large trade. This brings a lot of risks, so it is not advised to do so.
  • Know when to buy and sell. Consider using robo advising for crypto platforms.

The Bottom Line

Margin trading, also known as leverage trading, may not be best for the faint-hearted crypto newbie. To succeed in margin trading, crypto investors should have an excellent understanding of betting in this volatile market and a clear understanding of the risks involved.

Please take the time to read through our guide before starting your margin trading ventures. You can succeed in this realm with enough practice and risk management strategies.

Visit us at Pluto for more information today.

Sources:

What Is Margin Trading? A Risky Crypto Trading Strategy Explained | CoinDesk

What Is Crypto Liquidation & How Do I Avoid It? | Bybit Learn

Margin Trading Crypto: What It Is & How It Works | SoFi

What Is Crypto Margin Trading? | Cryptonews

Crypto Margin Trading: Beginners Guide to Leverage & Exchanges | Coinbureau

Understanding a Margin Call in Futures Trading | The Balance