Margin trading, also referred to as leverage trading, is a way to use debt to increase the size of a position. For example, a trader wants to bet on an increase in the price of Bitcoin. They could buy $10,000 worth of BTC and use it as collateral to take out a loan to buy a further $5,000 worth of BTC. That’s margin trading.
In this article we’ll explain how crypto margin trading works, the advantages of margin and most importantly, why margin trading can be dangerous for traders who don’t understand the risks.
How crypto margin trading works
Most people use leverage to buy a house or a car. In either case, the consumer puts down a deposit, let’s call it 20%, and then takes out a loan to pay the remaining 80%.
Margin trading works the same. A trader wants to increase their exposure to a cryptocurrency because they believe the price will go up. The trader buys their position and then uses margin trading to borrow even more of that asset. For example, a trader buys $5,000 worth of ETH and uses it as collateral to borrow an additional $2,000 worth of ETH.
Like any debt, the trader must pay to take out the loan. The borrowing rates frequently change depending on market supply and demand. Sometimes crypto margin trading is cheap, but when demand for loans is high it can be quite expensive.
Financial institutions are willing to lend assets to a trader because the loan is secured by the value of the trader’s collateral. If the collateral begins to lose value a trader might get a margin call (as happened recently to English pension fund managers). A margin call happens when the value of the trader’s collateral drops below a certain level.
For example, if the $5,000 worth of ETH loses value so that it’s only worth $2,500, the trader might get a margin call. Of course it won’t be an actual phone call, more likely an email or text alert. To avoid liquidation a trader must either close out their position at a loss, or add more collateral.
The following two methods are the most popular ways of margin trading crypto.
Margin trading on an exchange
Many crypto exchanges, such as Binance, offer margin trading. Traders who are registered on these exchanges can start margin trading within minutes. All they need to do is deposit some crypto and open a position.
Bitcoin margin trading on an exchange is probably the easiest way for most people to take out a leveraged position. However, the downside is that you must leave your crypto on the exchange. You can’t margin trade and then withdraw your coins to a hardware wallet or a non-custodial wallet like Exodus.
Traders who don’t have access to an exchange with margin trading, or who don’t want to use a centralized exchange, can also use DeFi to trade on margin.
Margin trading in DeFi
You can use a DeFi protocol like Compound or MakerDAO for crypto margin trading. The idea is the same as using a centralized exchange. The trader deposits collateral (typically ETH) in a DeFi lending protocol. The trader then uses the collateral’s value to take out a loan, usually paid in the stablecoin DAI. Once the trader has DAI they can use it to buy more crypto.
Just like a centralized exchange, an open position in MakerDAO or Compound has a liquidation price. If the position is close to that liquidation price the trader should either pay down their loan or deposit more collateral.
The borrowing rates for crypto margin trading in DeFi depend on what collateral is used and the collateralization rate. Traders who use ETH as collateral, and only borrow a small amount, will pay the lowest rates. Traders who deposit tokens as collateral, and take out large loans, will pay the highest rates.
The benefits of crypto margin trading
Margin trading crypto can be a good way to increase profits during a bull market. As long as prices are in a secular uptrend, using a bit of margin can help traders to make more money.
Also, crypto margin trading is relatively inexpensive. This is because most margin trades are fully backed by collateral which means the lender is not taking on much risk.
The risks of crypto margin trading
The biggest risk of trading on margin is that you can lose everything! If you’re margin trading crypto and the price of your collateral drops below the liquidation price, you’ll get wiped out. We see this happen all the time in crypto. Anytime there is a big market crash it’s normal to see hundreds of millions of dollars worth of liquidations.
Using 10 or 20x leverage is especially risky and should be avoided. Even a small move in the market can liquidate your position. If you want to margin trade crypto you should stick with 2 or 3x leverage.
How to buy Bitcoin and other crypto
If you start margin trading crypto first you’re going to need some crypto. Thankfully, you can buy Bitcoin (BTC) and other cryptocurrencies in Exodus, in any way you prefer:
- Use a credit / debit card, bank account, or Apple Pay. The easiest payment gateway, Ramp or MoonPay, is chosen for you depending on your region and availability.
- Exchange Ethereum and 200 other cryptocurrencies for Bitcoin (BTC) using the built-in exchange app.
This content is for informational purposes only and is not investment advice. You should consult a qualified licensed advisor before engaging in any transaction.