Over recent years, driven by demand from traders, margin trading has become exponentially more popular. From late 2017 onwards, many established spot exchanges, including Binance and Huobi, started offering margin trading of cryptocurrency futures and perpetual swap contracts, effectively replicating the BitMEX business model. At the same time, new margin exchanges, such as Bybit and FTX, also entered the market.
With so many new entrants to the margin trading market in such a short
space of time, it’s evident that exchange operators are eager to meet the
demand for margin trading.
What is Margin Trading?
The concept of margin trading comes from traditional finance, where a
broker will lend funds to their clients so they can open positions of a higher
value than the available balance on their account. Borrowing funds magnifies
the potential for gains and losses. However, traders are willing to expose
themselves to the additional loss risk for the opportunity to gain from smaller
movements in the price of an asset.
In the world of cryptocurrency, the exchange takes the role of the
broker.
When the trader opens the position, the exchange sets the liquidation
price as a means of protecting against losses. The liquidation price is the
value of the asset at which the exchange will liquidate the position as a means
of protecting against losses.
What are the benefits of offering
margin trading?
For an exchange, the main benefit of offering margin trading is the
potential for vastly increased trading fees. Fees charged as a percentage of
the value of the trade will multiply with the leverage used.
Offering margin trading is also likely to attract more pro and advanced
traders, who are more likely to make bigger deposits and open larger positions
than retail traders.
What are the risks of offering margin
trading?
Just as margin trading creates more opportunities for traders, exchanges
should also be aware of the risks associated with margin trading. Exchanges can
offset most of these risks by implementing a robust risk management system.
The exchange should clearly articulate its liquidation policy to ensure
it can liquidate positions that put the company at risk of losses. Many
exchanges, including BitMEX and Binance, direct a share of profits into an
insurance fund, which will ensure exchanges don’t have to implement “socialized
losses.” This practice involves penalizing profitable traders at the expense of
their losing counterparties, which can be highly unpopular and cost an exchange
in user numbers.
Margin trading in cryptocurrency markets
Margin trading is inherently riskier than regular trading, but when it
comes to cryptocurrencies, the risks are even higher. Owing to the high levels
of volatility, typical of these markets, cryptocurrency margin traders should
be especially careful. While hedging and risk management strategies may come in
handy, margin trading is certainly not suitable for beginners.
Being able to analyze charts, identify trends, and determine entry and exit points won't eliminate the risks involved with margin trading, but it may help to better anticipate risks and trade more effectively. So before leveraging cryptocurrency trades, users are recommended first to develop a keen understanding of technical analysis and to acquire an extensive spot trading experience.
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