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Exploring the World of Crypto Margin Trading

Exploring the World of Crypto Margin Trading

Discover the multi-faceted world of crypto margin trading, from high-risk, high-reward trades to low-risk strategies like statistical arbitrage that are only feasible with the use of leverage.

You’ve probably heard of margin trading and its potential to help you amplify your gains, but maybe you’re confused about the mechanics. Or perhaps you’re skeptical of some of the more sensational claims (and that’s a good thing!). Margin trading adds a lot of complexity to the trading process, but it can be an invaluable tool in the right hands.

In this article, you’ll learn what margin trading is, when you might want to use it, how it works, and some tips to achieve your goals without taking on unnecessary risk.

What is Margin Trading?

Traders employ many strategies to generate consistent profits in the crypto markets. For example, swing traders may use technical analysis to identify one or two trades that take weeks to play out and target 10% to 20% price movements. In contrast, day traders may use statistical arbitrage to execute hundreds of trades per day, generating a 0.0001% profit.

Since statistical arbitrage involves less risk for smaller gains, many day traders leverage margin to amplify their gains. They deposit a fraction of the total transaction value – the margin – and borrow the remaining amount from their broker. For example, 2:1 leverage enables a day trader to use $500 to purchase $1,000 worth of crypto.

There are two possible outcomes:

  • If the crypto increases in value, the trader benefits from the gains on the $1,000 investment minus any fees and interest.
  • If the crypto decreases in value, the losses are magnified, and the trader may face a margin call requiring them to deposit more funds to maintain the position.

Margin trading can be risky. For example, the swing trader in our example may be tempted to use a 2:1 margin to amplify their gains from 20% to 40%, but the longer holding period could significantly increase the risk – especially given crypto volatility! If the asset moved sharply lower, they could lose more than their initial deposit.

How Crypto Margin Trading Works

Margin trading requires a particular type of account, known as a margin account. After setting up a margin account, you’ll need to deposit an initial margin, typically a percentage of the total trade value, to initiate a margin trade.

How Crypto Margin Trading Works
Binance makes it easy to open a margin account. Source: Binance

When you open a margin position, consider it as borrowing money from the crypto exchange. But you aren’t borrowing the money for free – it comes with an interest rate. These interest rates could be calculated daily, hourly, or per minute, depending on the exchange’s terms. So, it’s always important to read the fine print!

For example, suppose you have an hourly interest rate of 0.001% and borrow 1,000 USDT at 12:30 and repay it at 14:30. The interest you owe is calculated by multiplying the amount you borrowed by the hourly interest and number of hours. So, 1,000 x 0.001% x 2 hours = 0.02 USDT – that’s the amount of interest you would owe.

The maintenance margin is the minimum amount of equity you must keep in your margin account to maintain an open position. If your account equity falls below the maintenance margin, the broker will issue a margin call demanding that you deposit more funds into the account to bring the equity back up to the required level.

For instance, if you have $1,000 worth of crypto assets, a $250 margin loan, and $25 in outstanding interest, your account equity might be $1,000 – 250 – 25 = $725. If an exchange has a 1.1x maintenance margin, you might experience a margin call. So, if the $1,000 in crypto falls below $725 x 1.1 = $797.50, you may be required to deposit more money or face a liquidation.

There are two types of margin accounts:

  • Isolated Margin – Isolated margin applies to a single position. So, any margin deficiency or liquidation will only impact that position and not your entire portfolio, making it best to limit the risks of highly leveraged positions.
  • Cross Margin – Cross margin involves sharing a margin balance across multiple positions. So, if one position has a margin deficiency, you can cover it with gains from another, reducing your margin call risk.

If you cannot meet the margin call or the losses worsen, the exchange may forcibly sell your assets at the prevailing market price to recover the loan amount. And in extreme cases, you could lose more than your initial deposit, making margin trading risky. However, some exchanges have “insurance funds” to prevent these scenarios.

Pros & Cons of Crypto Margin Trading

You’ve probably heard the phrase that leverage is a “double-edged sword.” It can be extremely helpful in battle, but it can hurt you if you’re not careful.

Benefits

  • Maximize Gains – Margin trading adds leverage to your trades, making it possible to generate more profits from the same pool of capital. In our example above, that turned the 20% gain into a 40% gain.
  • Broaden Scope – Margin trading opens the door to a broader range of trading strategies. For instance, statistical arbitrage would not make any sense without adding leverage because the price movements are too small.

Risks

  • Amplified Losses – Margin trading may add leverage to your trades, but that leverage cuts both ways. In the previous example, if the crypto you purchased lost 20%, you would be down 40% rather than just 20%.
  • Margin Calls – Margin calls can occur at inopportune times, particularly in the volatile crypto markets. For instance, if prices move sharply lower (even temporarily), you may have to liquidate your entire position.

5 Best Crypto Margin Trading Platforms

ExchangeCrypto PairsLeverageInterest
Binance600+Up to 10XTiered daily
Bybit400+Up to 100XFloating hourly
Kraken100+Up to 5XFixed daily
KuCoin100+Up to 10XFixed daily
BitMEX6Up to 100XFixed daily

Read our more in-depth review of top-margin trading platforms!

Tips & Best Practices

  • Start Small – Some crypto exchanges offer more than 100X leverage, but that doesn’t mean you should jump head-first into ultra-leveraged positions. Start with 5X leverage to understand how it works before moving up.
  • Limit Risk – Stop-loss orders can help you limit risk or lock in profits on any existing positions without requiring you to monitor the market 24/7. It’s also a good way to avoid the many behavioral finance traps and cognitive biases that can hurt performance.
  • Separate Accounts – Maintaining a maintenance margin is hard if you’re constantly adding and withdrawing funds. As a result, it’s advisable to separate your margin account from your other transactional or investment accounts.
  • Seek Quality – Margin trading is highly regulated in the United States, but that’s not necessarily true in other countries. While the terms may not be as attractive, these exchanges offer more protections and potentially better customer service.

The Bottom Line

Margin trading opens the door to new trading strategies and can multiply profits, but these benefits come with considerable risks. By understanding how margin works and keeping the tips we’ve discussed in mind, you can employ leverage to your advantage without falling into the many pitfalls that new traders experience.

If you trade crypto assets, ZenLedger can help you minimize stress during tax season. Our platform automatically aggregates transactions from wallets and exchanges, computes your capital gain or loss, and generates the paperwork you need to file. In addition, you can identify ways to save throughout the year with our tax-loss harvesting tool.

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This material has been prepared for informational purposes only and should not be interpreted as professional advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.

Justin Kuepper

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