To make the most of digital currency trading, margin trading is an option some are willing to consider. Yet, many have no full grasp of the potential pitfalls regarding this form of investment. The possibility of losing all is significantly higher, with repercussions amplified.
Given the high loss possibility with this type of crypto trading and the figures involved compared to investment value, some term it as crypto’s dark side. To better get what margin trading means as well as what the risks involved are, read on.
Trading on Debt
The simplest way of summing margin trading is to call it debt trading. It is where any type of crypto investor buys more crypto than they can afford. To make such a purchase, the investor uses borrowed funds to access larger capital volumes.
By trading using more capital than they have, they leverage their position to amplify trading results. The higher the capital a margin trader accesses, the more potential profits come without risking more capital investments.
The Dark Side
So far, so good, more profits are possible at similar capital volumes for a margin trader. It is even more visible when compared to normal crypto trading, where one invests in what they have.
But there is a very big “IF”. If price movements go well, good profits are a possibility. But if they don’t go as predicted, say a sudden bear market sentiment, hell will break loose. The investor will not only make as many losses as the normal investment way but also much more from the extra capital leveraged. And that’s borrowed capital that a margin trader should return to the lenders.
The Risks Involved
Margin trading involves several risks that every investor needs to be aware of. The risks range from during the trade to sometime after the trade has ended.
Crypto Investments on Your Account Can be Sold Without Your Consent
Many crypto investors believe that they have to know what is happening before the lenders start acquiring their investment. That is not the case. A crypto lending platform can enforce the possession of one’s crypto investment onto which the additional leveraged capital was added initially.
It is even worse if the platform is custodial. It can unilaterally acquire one’s crypto assets by accessing the wallet with its private key. Once the returns on investment move to negative.
Committing to Debt payments More Than Your Initial Investments
If the decline in the crypto value is significant, there is a very high chance of losing more than your capital investment. If the value of your coin investments makes a huge collapse, the threat of paying back to the lenders more than your investments is real.
High crypto price volatility makes the probability of incurring such a loss relatively high. In addition to one’s entire initial capital investment, extra financial commitments by the investor to the lender could become a requirement. That has the potential to mess with one’s financial position for an extended period.
No Time Extension Entitlement
Once a margin call occurs, the investor incurring the loss is not entitled to a time extension. Payment of the capital they received can be demanded immediately by the lenders.
Some special conditions may get an allowance to negotiate for a time extension. But even then, the time extension to be negotiated can be shot down by the lenders.
Is Open Short-sale Even Worse?
There is an even worse position one can find themselves than all the above, an open short-sale. During a normal trade, one can avoid paying their dues if the exchange in use delisted the crypto, no longer tradeable or halted.
The reality of margin trading is even worse where open short-sale is concerned. One is required to continue paying the balance plus interest accrued during the entire time after the loss of margin trading occurred. The investor is therefore tied to payments regardless of the position of their current financial situation.
A Very Risky Trading Position
While making more profits is an enticing prospect, there are many factors to be weighed. For starters, the potential to make more profits is just as high as reaping more losses.
In the event of a loss, many negative repercussions will occur. Consequently, one can lose part of their capital investment to serious positions such as a total loss and commitment for continued repayment. Margin trading is a high-risk option when trading in cryptocurrencies. All investors need to take their time to learn of all the risks involved with this type of trading.