Margin trading in cryptocurrency facilitates borrowing of money against the user’s current coins in order to assist them in carrying out trades in the cryptocurrency market. This means that the user can leverage their current cryptocurrency funds in the lending market to increase their purchasing power. The user, however, has to pay back interest on the loan to the lender and the money borrowed. Margin trading in cryptocurrency, therefore, allows a user to make bigger trades than their current funds would allow, involving far greater expenses and greater risk.
How does margin trading in cryptocurrency work?
A user has the option of opening either a short or long position with leveraged funds. A short position entails the user betting on the price of the cryptocurrency going down while a long position involves betting on the price going up. If the price goes the opposite of the traders bet, they incur a loss but if it goes in the direction they predicted, they make a profit.
After a user borrows funds, they have to pay back the total of the borrowed amount and the applicable interest rates regardless of how the trading goes. This means that if the user makes a trade betting that the price will go up but the price of the cryptocurrency instead goes down, they have to pay the incurred interest rates plus the initially borrowed money even though the trading activity was a loss. If it happens that the user’s balance falls below the maintenance margin requirement (MMR) as a result of the price of the cryptocurrency following an opposite trend to the one they had initially placed a bet on, the lender will ask for funds from user or automatically begin liquidating user’s assets to recover their funds. A cryptocurrency trader has to close their position manually to avoid further losses as well as a margin call by the lender.
Some of the reasons margin trading is considered a viable venture in cryptocurrency are:
1. It allows a user to leverage gains
Trading in cryptocurrency using leveraged funds allows a trader to buy more cryptocurrency than they would with their initial funds. This makes it possible to rack up a higher profit margin.
2. It facilitates hedging and diversification of a trader’s portfolio
Margin trading in cryptocurrency allows for hedging through the use of swaps or options. It can also be used to diversify into other cryptocurrencies, therefore, increasing potential profit gains.
3. It reduces the possibility of expropriating other investments
Trading cryptocurrency alongside margin trading techniques enables you to make trades without having to divest investments in order to raise capital for the trade.
Margin trading is practicable on most exchanges and it essentially increases the potential profits made if it is carried out properly as it is very risky and can lead to one losing all their initial capital. A user has to have a thorough understanding of how and when to open and close margin positions to eliminate the risk of loss.