What Does Margin Trading Mean in Terms of Cryptocurrency?
Margin trading with cryptocurrency allows users to borrow money against their current funds to trade cryptocurrency “on margin” on an exchange. In other words, users can leverage their existing cryptocurrency to increase their buying power (generally paying interest on the amount borrowed, but not always).
TIP: Some exchanges will only offer margin trading to investors who meet certain stringent criteria, others are more flexible (and will let you trade on margin if you have enough funds to cover the trade). For an example of an exchange that requires meeting a criteria, with GDAX you must be an Eligible Contract Participant (“ECP”, as defined in Section 1a(18) of the Commodity Exchange Act and applicable regulations thereunder). That generally means if you aren’t an accredited investor or don’t to have access to a good bit of capital individually or through a partnership, then you cannot do margin trading on GDAX. Meanwhile, Kraken allows margin trading for all of their Tier 1 – 4 clients.
Margin Trading on Kraken Bitcoin Exchange.
TIP: You’ll most likely want to “turn margin trading off” if “margin trading is on” when you first join a cryptocurrency exchange (as many exchanges allow margin trading). This will help prevent you from “making a leveraged buy on margin” while getting the hang of cryptocurrency trading.
“Imagine this: you’re sitting at the blackjack table and the dealer throws you an ace. You’d love to increase your bet, but you’re a little short on cash. Luckily, your friend offers to spot you $50 and says you can pay him back later. Tempting, isn’t it? If the cards are dealt right, you can win big and pay your buddy back his $50 with profits to spare. But what if you lose? Not only will you be down your original bet, but you’ll still owe your friend $50. Borrowing money at the casino is like gambling on steroids: the stakes are high and your potential for profit is dramatically increased. Conversely, your risk is also increased.”
– Margin Trading quote from Investopedia which explains how margin trading is like a casino… within a casino… within a casino…
How Margin Trading Cryptocurrency Works
With margin trading you can, for a theoretical example, buy $10,000 worth of bitcoin with only $5,000 (borrowing 50% AKA leveraging 2:1 or 2x).
You put down your $5,000, you borrow the other $5,000 from a lender automagically (generally either the exchange or other traders), and then when you sell you may-or-may-not pay a fee (that fee being interest on the money borrowed).
With that said, because you are borrowing money, you owe the money back (and when applicable a fee) no matter what.
That means if you bet on cryptocurrency going up, and it goes down or stagnates, and you thus sit on your coin, you’ll rack up interest (in cases where interest is charged). That also means if it goes down, you’ll owe back what you borrowed (plus any fees) even though you lost money.
If your balance falls below the “Maintenance Margin Requirement (MMR),” the exchange may start liquidating your assets to get its money back, or may simple request the funds from you, and this is called a “margin call.” TIP: This can be offset by contributing more funds to the order book you have the margin in (ex. BTC/USD). When you deposit more funds, you increase increase your margin ratio and improve your call price.
In other words, technical jargon aside, the concept here is: margin trading allows you to make bigger bets than you otherwise would, but at the cost of extra fees and extra risks.
That is the absolute gist of margin trading, with that you know just enough to be dangerous.
TIP: How much you can leverage differs by exchange and product type (for example on an exchange BTC/LTC might be 5x, but BTC/USD 2x). Other specifics will differ by exchange too, so always read the documentation before you initiate margin buying.
Should One Do Margin Trading?
With all the above said, we strongly suggest staying away from margin trading (as losing money trading cryptocurrency is stressful enough without losing borrowed funds plus interest).
Of course, if you are less conservative than us and want to margin trade anyway, your next step should be reading all the documentation on margin trading for a given exchange before getting started. Understanding how to open and close margin positions, and making sure you understand margin ratios and calls, and brushing up on some margin trading strategy, is the next step.
Don’t Margin Trade Crypto.
WARNING: Margin trading cryptocurrency is one of the most risky things you can do here in 2017. Cryptocurrency is risky and margin trading is risky, put them together on a 10x leveraged moonshot and you could find yourself owing big money quick.
TIP: Margin trades have time limits. If you can’t execute your trade in time, the leveraged portion of your trade my be automatically settled.
TIP: Margin trading essentially works the same way on stocks. In both cases, if the exchange will let you, you can short on margin too. That is perhaps even risker than margin trading in the first place.
TIP: One benefit of margin trading is that you can use it to keep less cryptocurrency on an exchange at a time. If you have a lot of cryptocurrency and want to protect it, it can make sense to keep the bulk of your funds in “cold storage” (an offline wallet) and to keep only enough on the exchange to trade with using leveraged buys (buying on margin).
- Bitcoin and Altcoins margin trading for beginners
- Intro to Margin Trading
- The Dangers of Buying on Margin
- Margin Trading
- Kraken Trading: Leverage and Margin