Bitcoin Margin Trading
Bitcoin margin trading permits investors to hold positions greater than their account equity would otherwise allow. For leveraged buying of cryptocurrencies, the fiat needed to buy the larger position is usually lent to the borrower either by the exchange or via a peer-to-peer lending marketplace. The borrower must then pay back the lender the original amount plus the accrued interest at a later date. This is all handled seamlessly through the exchange platform.
This lending mechanism also facilitates the shorting of cryptocurrencies. Essentially, bitcoin is borrowed and then immediately sold on the open exchange; assuming the price falls the originally borrowed position may be reacquired at the lower rate, the difference (minus interest) representing the borrower’s profit.
As a quick aside – this mechanism, offered by bitfinex, provides holders a decent way of earning an interest rate (a very small one, but if it is just sitting there anyways…) on bitcoin savings, by lending to short positions. Fiat lenders, on the other hand, can earn double digit interest rates per annum lending to long positions.
There are a number of different instruments that offer crypto margin trading; this article is limited to discussing margin accounts in which the borrower physically buys or sells the cryptocurrency asset; we discuss bitcoin derivatives in subsequent articles.
Bitcoin and Ethereum Margin Trading
Mainstream bitcoin exchanges like Bitfinex and CEX 0ffer margin trading, with either a 33% or 50% balance requirement. In other words, they allow for the purchasing (or shorting) of two or three bitcoin with just one held in your account, as collateral. This means that price movements in either direction are amplified accordingly – profit will be twice or three times as much, as will losses.
Bitfinex offers the most robust margin trading solution in the market (though they have made the unfortunate decision to bar US traders) with up to 3:1 margin offered on 16 different cryptocurrencies. Funding is secured through a peer-to-peer lending market, which allows lenders to fund margin accounts in exchange for interest payments. At a glance the current interest rate is .01359% daily, which comes out to an annual interest rate of 4.96%. In the event that the lending market dries up, Bitfinex is the lender of last resort; either way, borrowers needn’t concern themselves with the lending market, aside from checking on the rates; the lowest interest available is secured automatically upon placing the margin order.
CEX.io offers bitcoin and ethereum margin trading accounts as well, again up to 3:1. Though the initial .2% lending fee is a bit higher than average, the daily rate of .01% comes out to a very low 3.65% per annum.
The risks of Trading Cryptocurrencies Using Leverage
A wise man once said: cryptocurrencies are volatile. This is doubly (or triply) so when trading with leverage. The important thing to remember is that your entire investment can be lost when trading with margin, as if the market moves sharply against your position the initial coin might be required to pay back the lender.
In a normal market, however, your position will be liquidated in the event that the account equity falls below the maintenance margin requirement, generally set around 15% of the open position, but varied based on the exchange and the leverage.
Let’s use my current position at bitfinex to illustrate the associated risks. I purchased with my $356 of affiliate earnings a total of .364687 bitcoin at a base price of $3,977. To support this 3:1 position, I borrowed $1,094 from a lender. (As an aside, note that I have paid $0.38 in interest after one day of USD borrowing, or 12.5% annually.)
Now, to keep this position open it will be necessary to ensure my total account equity – the margin of $356.20 plus the P/L (currently $71.06) – is more than $217. That $217 point is hit when the base price of bitcoin is 3,600, or $581 below the current market price. If that price is hit, my position is liquidated and I get $217 returned to my account, a loss of $140, or 40%.
In real terms, however, the price moved only from $3,977 to $3600 – or slightly less than 10%.
Considering the swings that occur in the crypto marketplace from time to time, this risk is ample. This risk (and reward, it must be said) is relatively minor when compared to the high leverages offered from various bitcoin derivatives platforms.