With cryptocurrencies becoming increasingly popular across the globe in recent years, an increasing number of investors, both retail and institutional, seem to be entering this space at a furious pace. This is probably best made evident by the fact that over the course of Q1 2021 alone, the total market capitalization of the digital asset industry rose from $1trillion to $2 trillion.
As a consequence of this staggering growth, it has been observed that more and more crypto traders are beginning to utilize conventional stock market strategies in relation to their digital currency investments. Margin trading, in particular, is a technique that has gained an insane amount of traction in recent times.
In its most basic sense, margin trading refers to the practice of acquiring an asset (be it cryptos or stocks) by borrowing funds from a third-party intermediary such as a broker or margin lender in order to make a purchase that may otherwise not have been possible. Margin trading affords individuals the unique ability to rake in striking profits while presenting a high degree of financial risk in return.
Why All is the Hype Surrounding Margin Trading?
Margin trading — also referred to as ‘Bitcoin shorting’ by some cryptocurrency enthusiasts — entails the practice of buying/selling cryptos with a high degree of financial leverage, wherein individuals have the right to buy assets that are many times over their (sometimes up to 100x) financial limitations.
Say, if an individual has $5,000 worth of BTC in their margin trading account, by executing a ‘leverage trade’, they can open a much larger position than their existing account balance. Kraken, for example, enables traders to obtain a 5x leverage (so as to go long or short) on a variety of cryptocurrencies. Similarly, some trading platforms such as ByBit, Deribit, and BitMEX offer leverage ratios of up to 100x.
Margin Trading Offers Many Advantages
There’s no denying that margin trading is becoming increasingly popular across the global digital currency landscape, especially amongst younger investors who tend to use various smartphone-based trading and portfolio management apps to keep track of their holdings. In this section, we will look at some of the core advantages afforded by margin trading.
The most profound advantage that this technique offers is allowing individuals to draw in returns that are exponentially higher than their initial investment. For example, over the latter half of 2020, a pseudonymous trader by the name of RookieXBT was able to transform his life savings of 5 Bitcoin to a massive 40+ BTC using a variety of margin trading tactics.
Decent Profits on Smaller Price Movements
One of the most significant advantages of leverage trading is that it enables cryptocurrency investors to rake in handsome returns even when they have to deal with relatively low-price movements. Not only that, it also allows users to open multiple positions with a considerably low amount of capital.
A large number of traders tend to have their portfolios concentrated in a few assets such as Bitcoin, Ether, etc, however, through the use of margin training, they can utilize their existing holdings to obtain a margin loan. This money can diversify one’s portfolio without the individual having to sell their original crypto haul.
While the advantages offered by margin trading are impressive, at the same time, there are also many tangible risks associated with this technique that can — and should — not be left ignored. For example, due to its lucrative financial proposition, many new crypto investors are tempted to open risky positions, often leading them to incur massive short-term losses on day one itself.
Not only that, but since the digital currency market is faced with a high level of volatility on a near-daily basis, it is easier for investors to go into massive losses compared with the stock market. In this regard, while daily price swings of 5% are considered ‘red flags’ in conventional finance they are pretty routine in the crypto world.
Lastly. in certain stipulated agreement margin loan agreements, trading platforms are afforded the right to take serious action against any investors who are not able to fulfill their monetary obligations. For example, suppose an individual cannot meet their margin call. In that case, the broker has the authority to liquidate any remaining assets that may be present in the person’s account.
Is Margin Trading Worth It?
Similar to pretty much every financial instrument available in the market today, margin trading presents investors with a large number of benefits as well as significant risks.
Individuals entering this niche space should do their due diligence and open these risky positions only after doing their fair share of market research.