Among the many ways people trade cryptocurrencies, the terms “shorting” and “margin trading” often come up. Both these terms refer to the same practice which is leverage trading. As we know, the cryptocurrency market is extremely volatile, resulting in price fluctuations. These fluctuations exhibited by the market make it easy for traders to gain profits both in bull as well as bear markets through cryptocurrency leverage trading.
So How Cryptocurrency Margin Trading Works?
The simplest explanation of cryptocurrency margin trading is that traders are trading cryptocurrencies using borrowed funds. It involves borrowing capital at a relatively high-interest rate from an exchange that gives you the opportunity to access increased leverage. This process allows you to access increased profits if everything moves in your favor. However, it can amplify your losses as well.
When reading leverages, you have two options: going long, or going short. Going long refers to opening a long position. This involves the trader buying a contract because he/she believes that it will rise in value. On the other hand, going short refers to a trader selling a contract when he/she thinks that the price will decrease. They can afterward buy it back at a reduced price.
A portion of a trader’s account balance is held as collateral for the funds they borrow from the exchange. This happens as soon as they open a position. If the trader successfully closes a position at a profit, the exchange returns the collateral along with profits after deducting fees. However, in the case that the market moves against the trader and he/she loses, their trade will automatically be closed. The exchange will liquidate its collateral when the market reaches a certain price, known as the liquidation price.
Bitcoin Margin Trading and its advantages
There are various advantages of trading Bitcoin with leverage, one of them being the opportunity to profit just the same as someone with a lot of capital. This thus serves as a shortcut to fast-growing trading accounts that can benefit from higher returns. For instance, a trading account with $1000 can open a position worth $100,000 with leverage of 100x. If the market just moves by 5%, the margin account will profit by $5000. This is a lot more than what one would normally achieve($50).
Another advantage if the lesser capital requirements. This allows a trader to hedge their portfolios with multiple trades at the same time to decrease a trade’s exposure to risk. For example, you can open a short hedge for protection against the loss of an unsuccessful long position if the asset’s value decreases dramatically in value.
Crypto Margin Trading Mechanics Explained
In order to start margin trading, you need to initially deposit an amount to open a position, which is called an initial margin. You must hold a specific amount of capital in their account, called “maintenance margin” to keep their position. The leverage on offer will depend on the nature of the exchange in use, with some offering 200x leverage while others limit their leverage to 50x or 100x.
When you begin margin trading with cryptocurrencies, you will have 2 choices- either going short or going long. Going short means that you think the price of the cryptocurrency will fall while going long indicates that you expect the price to rise.
The exchange you use will hold collateral for your borrowed capital. When successful, the exchange releases the cryptocurrencies you deposited along with the gains. In case of a loss, however, the exchange automatically liquidates your position after ending your trade, after the relevant asset reaches the liquidation price.
However, the major difference here is that the risk in margin trading cryptocurrencies is not proportionate to the leverage. For instance, losing trade with 100x leverage will not multiply a trader’s losses by a hundred times. However, theoretically, losses can exceed committed assets in some sectors. Initially popular in slow-moving, low volatile markets such as forex, margin trading or leverage trading has started to become popular when trading cryptocurrencies as well.
Risks of Bitcoin Margin Trading
The main thing to take into consideration when margin trading bitcoin is the fees, as they are different depending on the exchange used. They are typically applied not on the initial investment, but on the increased position size. In some instances, the broker or platform may charge an additional funding fee for margin trades.
The risk of loss is also amplified when using bitcoin margin trading. This is due to the margin being fractional when compared to the leveraged position size. The margin is used up when the price moves in the opposite direction to what the trader expects or anticipates.
What Are Leveraged Tokens?
Traditionally putting on leveraged positions or shorting on spot exchanges was impossible. Traders usually traded on margin on exchanges like Bitmex, Okex, and Bitfinex which offer futures speculation. This makes it complicated for retail traders because of the borrowing costs, funding costs, and the risk of margin calls.
Leveraged tokens allow traders to take short or leveraged positions without requiring to trade on margin on futures exchanges. For instance, say you want to 3x short Bitcoin. You can buy a 3x short bitcoin leveraged token from an exchange and do the same. There are leveraged tokens in existence for cryptocurrencies such as Ethereum, Ripple, EOS, Tether, Binance Coin, Tron, Bitcoin Cash, and of course, Bitcoin, allowing you to trade in a more capital-efficient way.
When trading leveraged tokens, traders do not have to worry about additional costs or the risks of suffering a margin call every token is rebalanced daily to ensure that the leverage ratios of the underlying assets are maintained. Also, leveraged tokens reduce exposure, greatly reducing the chances of liquidation. The token is a combination of a position in crypto asset and the balanced position in futures based on this specific coin.
Examples of leveraged tokens include the following
|Name of token||Value as of 9/10/2020(coinmarketcap data)|
|3x Long Bitcoin Token (BULL)||$3,069.97 USD|
|3X Short Bitcoin Token (BEAR)||$0.766940 USD|
|3X Short Ethereum Token (ETHBEAR)||$0.077759 USD|
|3X Long Chainlink Token (LINKBULL)||$687.70 USD|
|3x Long EOS Token (EOSBULL)||$1.16 USD|
|3x Long Bitcoin SV Token (BSVBULL)||$0.307880 USD|
|3x Long Litecoin Token (LTCBULL)||$1.63 USD|
Trading with leverage in the cryptocurrency market, just like any other market, can present opportunities for amassing a fortune through multiplied profits. However, one should also recognize and understand how to deal with the inherent risks associated with this method. In the case of the cryptocurrency market which is still in its fledgling stage, proper risk management rules should be implemented to guarantee success in the long run.