Cryptoasset Margin Trading: How Safe is it?
The major digital asset trading platform, Binance, recently announced that it now also supports margin trading and warned that it “is highly subjected to market risk”. However, in a recent interview with Bloomberg, Binance CEO, Changpeng Zhao, said that the margin trading offering is “quite safe to use, to be honest,” which may be a surprise to hear for some given that margin trading is widely considered a high-risk venture.
In this article, we will delve into margin trading and discuss how risky or safe it can be for different types of investors.
Binance launches margin trading
As Cryptonews.com reported on July 11, Binance, launched its new margin trading platform, called Binance 2.0, to enable traders to take leveraged trading positions on digital assets.
On the first day of trading, over 10,000 traders reportedly signed up to the new margin trading platform, borrowing over USD 15 million.
Currently, Binance allows traders to borrow to gain a maximum of 3:1 leverage to amplify their returns (or losses).
What is margin trading?
Margin trading, also known as leveraged trading, refers to borrowing funds so that you can take a larger position than you would be able to with your existing funds so that you can potentially generate a higher profit.
For example, if you want to go long bitcoin (BTC) with a leverage ratio of 2:1, you could use USD 1,000 of capital and borrow funds so that your potential returns would be doubled. If the price of bitcoin then moves from USD 10,000 to USD 12,000, your return would not be 20% but 40%, which would equate to USD 400 instead of USD 200, in this example, minus the daily borrowing fee.
Margin trading is prevalent in the forex markets, where it would otherwise require traders to place a large amount of capital on each trade to benefit from small price movements in currency pairs. As a result, CFD (contract for difference) trading has become very popular for at-home forex traders.
Margin trading has also gained popularity in the cryptoasset markets with the likes of Bitfinex, BitMEX, Kraken, and Poloniex having lead the way with their leveraged trading offerings for bitcoin and co.
While margin trading enables traders to amplify their returns, it can also lead to increased losses, which is why experienced traders tend to advise newcomers to stay away from leveraged trading.
Is cryptoasset margin trading safe?
The answer to that question is two-fold: Relatively yes, if you know what you are doing. Definitely no, if you are a beginner.
Binance wrote in the disclaimer under its Binance 2.0 launch announcement: "Please be mindful that margin trading is highly subjected to market risk, volatility, and complexity."
That is a fair assessment of leveraged trading. To successfully trade using leverage, you need to fully understand the risk involved and know how to manage that risk.
If you are a beginner and want to go long bitcoin because you believe that the price will surpass its most recent all-time high in the coming months, it may be tempting to add leverage to the equation to increase your potential returns. However, bitcoin is volatile and a margin call may just be around the corner.
As we witnessed in the past two weeks, the price of bitcoin can easily rally or drop by 10 to 20 percent within a day or two. If you are long using leverage, you will need to have sufficient funds on your margin trading account to cover adverse price movements. If you do not have enough funds, you will receive a margin call if your trade moves against you, which means you will have to add more funds to your trading account to cover the (temporary) loss on your margin trading. If you do not have sufficient funds on your account and you do not respond to the margin call, your trade will be closed out automatically by the exchange and you could lose more than your originally invested funds (depending on the leverage ratio and the price movement).
This scenario shows you can easily lose money when placing margin trades, which is why it is generally recommended to stay away from margin trading if you are a newcomer to trading.
In light of the high volatility of most cryptoassets, margin trading digital currencies and tokens can be considered even riskier for inexperienced traders than stocks or forex.
For experienced traders that know how to manage their risks, have sufficient trading capital and are comfortable with leverage, margin trading is not necessarily much riskier than other types of trading.
The key to successfully trading crypto on margin is risk management. That means clearly defining your target prices and stop-loss limits, knowing the assets you are trading and its market drivers well, managing your money according to your risk profile, and, of course, never investing more than you can afford to lose.
Additionally, it is important to note that because exchanges close out losing positions if the margin requirements are no longer met, large losses are automatically avoided. Hence, the downside risk is generally capped even if you do not set a stop-loss limit.
While beginners should probably stay away from margin trading, for experienced traders who know what they are doing, leveraged trading can be an excellent way to add returns.