What is margin trading? It made countless traders rich and bankrupt. Warren Buffett avoids it like a plague. A tool for those who are very certain in their actions, and for those blinded by arrogance. Yes, that can be both profitable and dangerous. Margin trading means trading with borrowed money.
Who lends money to margin traders? Brokers or exchanges, in some cases - other users. It’s not always an option, many exchanges don’t allow margin trading, for some reasons, but we’ll talk about it later.
How margin trading works
Why would you ever need more money to trade? To make even more money. Let’s imagine you have $100 to trade with. Your allowed margin is 3:1, that means you can borrow up to $300 with your $100 as collateral. You buy, let’s say, 3 Ethers for $100 each, and the price grows to $300. How much did you earn? You sell these 3 ETH for $900, return $300 that you’ve borrowed, and see, you’ve gained $500 (plus the original 100 bucks that you owned)! That’s 5 times more than you had. It’s very handy if you want to make bigger profits.
The amount of available margin is called leverage. The more leverage you have, the more risks are there. Standard trades without any margin have a leverage of 1:1. Shorting any asset is always a margin trade because it requires selling something you don’t have, thus borrowing it. The same rules apply both for long (i.e. buying) and short (i.e. selling) positions. And don’t forget that aside from a fee for opening a trade you have to pay a funding rate for borrowed money, every single day of keeping your position, the rates differ from exchange to exchange.
The most essential in margin trading is maintaining your collateral funds. Remember: if your collateral will drop below some predetermined amount, so-called maintenance margin requirement, your positions liquidate automatically. What does it mean? Let’s suppose that the maintenance margin is 15%. Our imaginary trader William enters the position in ETH at $100, buying 3 Ethers with 3:1 leverage, but suddenly it goes down. Where will it be liquidated? The answer is “at $79 per 1 ETH”. Initially, William has 33% of collateral, the maintenance margin is 15%. With every $1 tick down of price, William loses 3 dollars. When the price reaches 79, our trader has lost $63, and the remaining $37 are equal to 15% of the borrowed 237 bucks. His position gets liquidated, William goes broke. Don’t be like William.
How is it possible to maintain a proper margin? Let’s see in the next part.
Collateral for your leverage: practices of BTCNEXT and other exchanges
Usually, all funds combined on your account, Bitcoin, altcoins, and stablecoins are considered sufficient collateral, and their value defines the amount of funds that you can borrow. The most convenient asset for this purpose is stablecoins because their value doesn’t swing up and down in a crazy way. There are lots of various stablecoins on the crypto market, and most of them are good enough for trading, you can rely on them, the only thing that is totally necessary for them is to be backed by their issuer’s funds.
Let’s take BTCNEXT as an example. There are several types of stablecoins on the exchange. The first stablecoin, serving the role of dollar currency, is USDT (Tether). It’s pretty popular on many exchanges worldwide, due to its high market cap. However, Tether is a very controversial stablecoin with a shady activity, and it’s still unclear if its issuer has the funds to back all USDT tokens.
There’s a safer alternative - Q DAO family of stablecoins, that includes USDQ (USD) and KRWQ (Korean Won) developed by Platinum Q DAO Engineering. That’s a large company, whose main specialization is developing and organizing STOs/IEOs, market making, and marketing. Q DAO stablecoins are collateralized by 198% backing in BTC, and totally decentralized - the issuer can’t take all funds and flee. Thus it’s very convenient for you to hold them for margin trading and it’s safe for BTCNEXT to lend you money in exchange for these funds.
Can you hold Bitcoin and altcoins as collateral when trading crypto assets? Sure! But remember one thing: when the market goes down, your collateral also diminishes, thus increasing the risk of being margin called.
Always manage your risks
Some types of exchanges don’t allow margin trading, because it’s too risky not only for borrowers but also for lenders. There’s a term “order slippage”, it means the difference between the expected price of a trade and the price at which the trade is executed. During the times of low liquidity on the market, there could be insufficient amount of buyers or sellers to liquidate a margin position instantly - there won’t be anyone on the other side of the trade willing to buy/sell at the required price, and the order will be executed at the next available price, resulting in the loss of borrowed money. There was such incident in 2017 on Bitfinex - an extreme sellout wiped out the whole order book. When liquidations started to execute, the assets of margin traders were sold at a very unfair price. For example, NEO, that was valued at $32 a few hours earlier, was sold at $3 dollars. Some of the traders ended up with thousands of dollars of negative balance, starting with $80k+, ending with the debt of $32k. That became the problem of the exchange and the lenders, the other users, who lendt money to margin traders for fixed interest, and this money was slost.
Another risk is being overleveraged - some exchanges such as Bitmex, allow crazy leverage, up to 100:1. Needless to say that even 1% movement in the wrong direction liquidates your funds. There’s even a special Twitter account Bitmex REKT, which posts the losses of rekt trades. We don’t want to end up there, right?
So, what have we learned from this article? Margin trading, like any other type of trading, can be profitable or destroy your money. It depends on skill, proper risk management, and a little bit of luck. If your luck abandons you - the risk management and skill save you. If you decide to try margin trading it’s better to start from a small margin, not overleveraging yourself. For example, you can start here, on BTCNEXT, which is reliable and secure. Good luck in successful margin trading!
BTCNEXT exchange, the next generation spot, and margin-trading platform, has been developed by Platinum Q DAO Engineering, which has also brought USDQ and KRWQ to the market, looking to edge together innovative solutions in collateralization. They plan to achieve it by using stabilizing mechanisms and neural networks for high-endurance stable coins.
The one aspect of USDQ which makes it unique is that this stablecoin is decentralized. It has Bitcoin as a collateralized cryptocurrency debt backing up its value, instead of a centralized authority holding dollar bills, as in the case of Tether (USDT).
In order to protect investors’ funds, BTCNEXT developers have implemented more than 300 security measures. In the near future, users will be able to trade over a hundred types of tokens including Bitcoin, Ethereum, and Litecoin. For more information, visit their website and follow them on Twitter, Instagram, Telegram, Facebook, Medium, or LinkedIn.