The Ultimate Guide to Crypto Margin Trading

When done right, crypto margin trading can single-handedly be the best choice you make in your crypto investing career.

Most people are aware of the concept of leveraging – whether it’s leveraging money, people or time.

Some people leverage unknowingly, like in real estate when you take a mortgage to buy a house.

Few people know how to utilize leverage properly, and that’s especially true in crypto margin trading.

If you frequently surf Reddit, you’ll notice the “I lost everything” posts like these circulating once in awhile.

Here’s a brief excerpt of what one of these posts said:

crypto margin trading excerpt

The last paragraph was what prompted me to write this post.

“If you don’t know what you’re doing, do not mess around with margin trading and leverage.”

There’s simply far too many crypto investors who leverage but doesn’t utilize leverage properly.

Hence, we’ve set out to write an Ultimate Guide on Crypto Margin Trading. Our guide here will teach you the following:

  • What Exactly is Margin Trading?
  • Common Pitfalls for Crypto Margin Traders
  • Best Exchanges for Crypto Margin Trading

What Exactly is Margin Trading?

Margin trading is a form of leverage, where essentially you are borrowing funds from external parties in order to increase your exposure into a particular investment.

For example, if an investor had 1 ETH and was interested in leveraging to increase their position further, they might consider putting down 1 ETH as collateral to receive a $500 USDC loan, which they would then use to invest into ETH again.

Assuming ETH was at $250, they would be able to afford 2 ETH, leaving them with a 3 ETH balance at the end of their trading session.

If ETH climbs $10 the next day and the investor sells, they would receive returns of $30 (3 ETH * $10), whereas if they had not leveraged, they would’ve only received returns of $10 (1 ETH * $10).

This is what we call a 3x leverage because the investor had increased his exposure three-folds, amplifying both their potential gains and losses by 3x.

Obviously in the example above, the outcome of the trade was favorable for the investor as the investor exited with a positive return on their investment.

If ETH had fallen instead and continued to fall even further, then a forced liquidation mechanism eventually occurs where the investor’s assets are automatically sold to the market in order to repay the lender.

Margin Trading Rules 

Every exchange has their own trading rules when it comes to margin trading.

Binance, for example, allows a user to borrow on a 3:1 ratio, or 3x leverage. If you hold 1 BTC, you can borrow 2 BTC more.

If a user’s trading balance falls below the 3:1 ratio, a Margin Call is sent out to the user, which is a warning to inform the user that their investment is close to getting liquidated.

Once the user is below a 10:1 ratio, their assets are liquidated to repay the debts, which is equivalent to a 100% loss on investment.

On the other hand, another exchange may allow a user to borrow on 4x leverage, but liquidation happens at a 6:1 ratio. A 6:1 ratio would mean there’s less flexibility in how far down the price goes before the collateralized assets are force liquidated.

Generally speaking, the points below are the margin trading rules which are likely to differ between exchanges:

  • Initial collateral – which is how much you need to have as collateral in order to borrow a specified amount
  • Maximum collateral – or the bare minimum you must maintain as collateral to prevent a forced liquidation
  • Liquidation Penalty – for centralized exchanges, you would normally lose 100% of your investment during a forced liquidation. However, for decentralized exchanges, a maximum collateral greater than 100% is generally required to borrow on margin, and a liquidation penalty could be charged on your over-collateralized balance
  • Interest rate – the borrowing cost for trading on margin
  • Expiration period – some exchanges impose a maximum period for how long you can open a position, others might have no expiration period
  • Max slippage – applies only to decentralized exchanges and refers to whether a trade will actually go through if the initial price point you wanted to invest at has changed while your trade is still being processed on the blockchain
  • Trading pairs – different exchanges have different trading pairs or tokens available for margin trading

Common Pitfalls for Crypto Margin Traders

As margin trading is inevitably a higher risk investment strategy, there are a couple of key things you should watch out for.

Below, I compiled a list of very common pitfalls that crypto margin traders fall into:

1. Low Liquidity and High Spread Exchanges

Regardless of what type of investment asset you’re looking at, liquidity is always going to be one of the most important factors to watch out for.

Anecdotally, I’ve noticed that retail investors pay A LOT less attention than professional traders and institutions when it comes to how liquid a particular asset is, whether it’s crypto or a more traditional investment asset like stocks.

When I ask my friends who work at hedge funds what the most important factor to watch out for is for investing in any type of assets, many of them say liquidity because if you can’t exit your position, it doesn’t matter how much you gain on paper.

Even if you can exit (most of the time you can), you’ll end up taking a big loss on the spread.

This is an extremely important factor to consider when trading in crypto, and especially so for crypto margin trading.

Let me give you a real example from a fairly popular decentralized platform – dYdX.

dYdX offers two trading pairs for leveraging ETH – in particular, the pairs are ETH/DAI and ETH/USDC.

This is what the order book looks like for the two trading pairs.

For ETH/DAI

eth/dai orderbook dydx
ETH-DAI Order Book - July 12

For ETH/USDC

ETH/USDC order book on dydx

From the images above, the first thing you’ll notice is that the prices are VERY different for both order books.

Just for reference, ETH’s price was roughly $275 for the ETH/USDT pairing on Binance at the time I took the screenshots. This aligns with the ETH/USDC pair on dYdX, which matches the price on other exchanges fairly well.

However, for ETH/DAI, you’ll notice that the highest bid is $281 and the lowest ask is $284 – so even the highest bid is a whopping $6 higher than fair market value.

Just to show how significant this is, let’s say you leverage ETH through the ETH/DAI pair right now on 3x.

First of all, you’ll be entering a position at $284, which is $9, or well over 3% higher than the existing $275 ETH price on other exchanges.

This is due to market inefficiency – there just isn’t enough arbitraging going on to consolidate the prices together on smaller exchanges, but as the investor, you’d ultimately pay the price.

If at some point, the ETH/DAI pair consolidates to the fair market value of other exchanges, ETH/DAI would drop $9 down to $275, and you would lose on minimum 3% * 3x leverage = 9% paper loss. This is a risk you’d be adding onto your belt for no additional benefit.

Another thing to consider in the example above is the bid-ask spread.

You’ll notice that the spread between the lowest ask and the highest bid on ETH/DAI is 2.95 DAI, which equates to over a 1% spread.

That means if you enter into a position through ETH/DAI for $284 at 3x leverage, and you immediately sell out afterwards at $281, you’ll immediately incur a 3% loss (3x leverage * 1% loss).

Without having done anything at all, you’re already at a 3% loss.

Which is why it’s extremely important to look at the liquidity and spread of the exchange before you commit to opening a position.

2. Refusing to Exit on a Loss

Refusing to exit on a loss is one of the biggest pitfalls for crypto margin traders.

Here’s an example of what it might look like in case you aren’t sure if you’re falling into the same pitfall as other unfortunate traders.

So – you’re leveraging a position at 3x, hoping to make a gain and instead the price move backwards, falling 10%.

All of a sudden, you’re down 30% (3x leverage * 10%) on your initial investment and you feel like if you keep your position open, it’s going to recover and you’ll make back your losses (and more), so you keep your position open.

Two days later, the price drops another 10% and you’re left with just 40% on your initial investment. You have no idea what’s going on – devastated, you decide to hold longer in hopes of a recovery.

Then, it falls 10% one more time and you’re left with nothing.

That was pretty much this guy on Reddit here: (well he went through a few more ups and downs but you get what I’m saying)

Redditor force liquidated

So what’s the solution to avoiding this pitfall?

Simple, you should set an exit strategy and uphold your strategy before going into a trade.

Decide how much you are willing to risk – if it’s no more than 20%, then exit when your position goes below 80% and don’t look back.

Think about it this way: If you originally leveraged with the expectation of the asset going up 20%, but instead it fell 20%, you now need it to move up 50% in order for it to achieve your original goal of gaining 20%. How likely is it that the asset will run up by 50% within your given timeframe, without it dropping below your liquidation price?

I think it’s more likely that it’ll drop another 20% and liquidate you before you can get to your initial goal – so keep your losses short or you might end up losing everything.

3. Doubling Down on a Losing Position

This is related to Refusing to Exit on a Loss but I think it warrants its own section.

It’s very easy to feel euphoric when Bitcoin has just run up 30% and it seems like there’s nothing stopping it from running up more.

This slight drop is probably just a consolidation, it’s a ripe time for me to double down.

It doesn’t matter whether you end up gaining or losing on this choice.

The moment you make the decision of doubling down, you’re fucked, because even if you gain, you’re going to repeat doubling down on every “consolidation” and at some point, you’ll be so heavily invested that one drop will lose everything you’ve earned and more.

At the end of the day, no matter how sure you think the asset is going to keep moving up, you shouldn’t margin trade on such a large percentage of your portfolio because margin trading is still a high risk strategy.

But also, just think: there shouldn’t be any reason for you to risk such a large percentage of your portfolio.

One of the biggest advantages of leveraging is that you can gain more exposure with less.

Consider this:

If you had $10,000 to invest with and decided to use 10%, or $1,000 to leverage on a 3x position,

Then essentially, you would be trading on a position worth 30% of your total net assets ($3,000 of $10,000) by using just $1,000 – and that’s already very significant!

You still have $9,000 to invest elsewhere, to diversify and reduce your risks.

Best Exchanges for Crypto Margin Trading

There are both centralized and decentralized exchanges for margin trading, with pros & cons for each.

For decentralized exchanges, the main benefit is that you have self custody of your funds – which drastically reduces the exchange risk of trading on a centralized exchange and having your funds hacked, frozen, or stolen.

While for centralized exchanges, the benefit is that it tends to be more liquid with a lower spread, plus there’s usually a much lower collateral amount required meaning it’s less likely to get liquidated.

I’ve compiled a list of the most popular centralized and decentralized exchanges for crypto margin trading down below:

Centralized Exchanges

Binance

As one of the leading exchanges by volume in the world, Binance is probably the best exchange for margin trading on a centralized platform.

They currently offer margin trading for 6 cryptocurrencies – BTC, ETH, BNB, TRX, XRP, and USDT, offering more trading pairs than any other exchange in the market.

binance logo

Nexo

Although the main purpose of Nexo is to provide accessible line of credits with ease, Nexo can also be a great alternative to Binance for crypto margin trading.

You can borrow 23 different types of crypto assets, which can make Nexo an amazing platform especially if you’re looking to short a position on certain altcoins that you might not be able to borrow elsewhere.

nexo logo

Decentralized Exchanges

MakerDAO

Creator of the DAI stablecoin, MakerDAO was one of the first projects that enabled decentralized loans which most people use for margin trading today.

The main pullback with margin trading with a MakerDAO CDP loan is that you’d only be able to borrow DAI, which drastically limits your trading flexibility on which pairs you want to trade against.

You can learn more about creating a CDP here.

Maker logo

Compound

Compound is a peer-to-peer lending platform where you can both borrow or lend out your crypto assets.

Essentially, all the assets are pooled together and both the lenders and borrowers earn or pay on a global rate based on the algorithm and the overall supply and demand of the platform.

There are no expiration periods for the loans and the liquidation penalty is fairly low, making Compound a decent choice for small leverages.

dYdX

For those looking to leverage more on a decentralized platform, dYdX is probably the best choice for you.

Out of all the decentralized platforms available, dYdX is the only exchange to allow up to a 4x leverage, while most other decentralized solutions are 3x leverage.

Watch out for the slippage %, however, as there’s usually a 1% slippage rate set which means you might end up starting your position at 4% worse than expected when leveraging at 4x.

Conclusion

Hopefully I hope this article has given you an overall better understanding on crypto margin trading.

As mentioned throughout the article, the key is really to play on the strengths and benefits that margin trading can bring – which is more exposure with less capital.

If you’re looking to trade $10,000 in ETH, you’d normally have to risk $10,000 in capital.

However, with margin trading, you can allocate $3333, and instead trade on 3x leverage to trade $10,000 in ETH – overall you’re risking less capital and have more to spend or invest elsewhere.

The mistake most new investors make is that they tend to over-leverage. Instead of allocating $3,333 to trade $10,000, they’re instead allocating $10,000 to trade $30,000.

And when losses start piling up, they double down or they refuse to close – resulting in a 100% loss in capital.

Here, I write this article in the hopes that you’ll take what I have written and leverage what others have learned to avoid the same painstaking choices they have made.

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