Learning the basics
The subject seems quite obvious but let’s walk it baby steps anyway. In essence, margin trading crypto is buying something with money you don’t have, or selling assets you don’t own. The simplest example possible: there is $100 worth of Bitcoin in your exchange wallet, and you believe the price will move higher. You ask the exchange to lend you $400 extra and buy more of the cryptocurrency you chose (BTC, in our example). To establish the vocabulary, your initial $100 are the collateral, and the $400 added are leverage, and the ratio you use is 1:4, or, in other terms, you cover 20% of the deal.
If the trade is successful which in your case means the market move up, you get the profit. Exchanges are not charities, and they will earn from your activity regardless of the results but the good thing is everything is quite predictable.
The exchange will deduct:
- trading fees when the margin amount is bought;
- interest on the lending provided;
- and another round of commissions when the asset is sold.
Margin trading cryptocurrency works the same way as it is in traditional finance. There is one difference, though. Have a look at stocks: you may have Apple, Microsoft and Exxon in your portfolio, and USD will represent the rest. When you pledge your assets and get some extra financing, technically speaking, you receive more USD, and then buy or sell things you want. At crypto trading platforms, there are often direct trading pairs not only for Bitcoin but for Ethereum, and even the exchanges’ native tokens.
Selection of tokens and coins listed may differ from one exchange to another. Nominex, for example, has all the liquid names and concentrates on maximizing liquidity in those instead of losing focus. But regardless of the exact list, for crypto the term ‘margin funding’ is more commonly used. This illustrates cases when both the collateral and the leverage are tradable assets.
Where does it comes from?
To facilitate margin trading, crypto exchanges need to:
- introduce proper software;
- establish adequate risk management systems;
- source funding.
With items one and two this is ‘simple’: you create a trading platform, hire a team, spend months and months building the product, testing and releasing it, and after a year or so, with you hear completely gray, you’re out. We in Nominex know that for sure.
When it comes to funding, the situation gets kinda tricky and interesting: de facto, trading platforms don’t need any own funds to source leveraged deals. Both mathematically and administratively. Let’s run another example here, like the one we started with: you trade BTC to USD pair, and get extra $400 on the hundred in your account. The market moves, however, in the other direction, not the one you expected.
Every 1% of the move cuts your deposit by 4%, right? So if you took long position in Bitcoin, it must make -25% to wipe out what covers your risk. Pretty harsh. Daily changes like that did take place historically but they were pretty rare.
To have margin trading crypto explained promptly, let’s have another look at liquidation price. This is a point where the broker or the exchange has to sell you off forcedly. In our example with 1:4 leverage, you start at $6,000 per BTC, and you’ll be closed at $4,500. Risk management here really depends on the liquidity of every coin, if it trades in a wide range and slides are big, the liquidation point will be somewhat above to compensate on the slide. The service cannot afford to lose money, neither its own, not other clients’.
High leverage regular trading, thus, is available only in very liquid and actively circulated assets. Margin call is a painful procedure, and cryptocurrency margin trading rarely allows buying into illiquid stuff with big leverate. Forex is a different story: with plenty of liquidity and very thin moves from tick to tick, they can afford more credit. Professional traders in forex take 10x leverage for granted but what they do seek is 50x-100x ratios.
Blockchain technology related margin trading
Crypto margin trading platforms opened a whole new level of margin funding and trading. And Nominex sees this activity as an important part of its business and service. In addition to fiat currency, borrowed money here can be used to buy exotic stuff, like 2-3 tier tokens, that is why quotation lists do matter, and traders must act smartly when picking their basic exchange. Unlike in standard trading, where you would want both the collateral and the marginally bough asset to be liquid, with BTC being the underlying asset and the pricing unit in the same time this problem disappears. Another option of a similar nature is margin funding covered participation in token sales. This can be an interesting opportunity for investors with diversified long-term portfolios, and Nominex works to offer them solutions these traders demand.
Here are some basic tips for those starting crypto margin trading:
- read the fee schedule carefully taking into account all discussed in the section above; at Nominex, the fees are low and predictable, and you can cut those further by (a) using NMX tokens to pay commissions, and (b) reduce the burden by achieving higher status in our referral program; on top of that we offer lucrative discounts in Nominex discount packages;
- study stop, stop-limit, trailing stop, trailing stop future orders most advanced exchanges offer; Nominex offers these types of orders, and even more sophisticated solutions;
- get to better understand currency pairs you are up for; we offer you to test all strategies you might pursuit in the Demo Mode first where losses can be avoided while experience and knowledge of the market still gained in full.
Bitcoin margin trading has its pros and cons, and it really depends on the conditions your exchange has to offer. Whether you need to pass higher KYC levels (at Nominex you need to take some very basic steps, and withdrawals up to 3 BTC don’t require any at all), and how flexible are margin calls with this particular platform. Does it offer similar terms for long and short? What period of time does the leverage cover, and more.
Before opening a position, measure all your risks carefully. Don’t put on the table everything you own, regulate the level of leverage you accept, and avoid damages: once you see the market driving the wrong way, jump out of the exploding car (i.e. cover the position yourself instead of forced closure). Try your best in the Tournaments Arena to win prizes with no risk, and use the real prize money as your starting capital in the market.
To stay on the positive side, let me wrap this up with two quotes on risk taking. “Security is mostly a superstition. Life is either a daring adventure or nothing,” — Helen Keller said. And the more ancient one comes from the great Seneca: “It’s not because things are difficult that we dare not venture. It’s because we dare not venture that they are difficult.”
Trade smartly and use leverage, when appropriate.