5 Tips on Why You Should (And Shouldn’t) Buy Crypto On Margin
What if someone can go back in time and buy bitcoin or any of the other hot cryptocurrencies three or four years ago? What if the same person would have been able to borrow funds from a broker to amplify the investment’s return?
Such a scenario was very realistic thanks to the growth in demand for trading cryptocurrency on margin.
Trading on margin is an industry-standard practice across all asset classes. Many investors have been using margin to trade stocks, buy gold, or speculate on oil future contracts for decades.
While the introduction of margin in the cryptocurrency universe is fairly new by comparison, the concept is identical to all other asset classes.
But just because an investor can buy cryptocurrency on margin, it doesn’t mean they should.
What Is Cryptocurrency Margin?
Trading cryptocurrency on margin is becoming a more important feature that brokers are offering clients and investors can find relevant information from a cryptocurrency margin trading guide.
In essence, the broker loans funds to the client to use in their trading or investment account. Buying cryptocurrencies on margin is often interchanged with other terms like leverage or buying on credit.
The amount that is loaned is expressed as a multiplier on the cash balance. For example, a $5,000 deposit onto a brokerage account that offers a margin of 10 times would let the client have access to $50,000 to trade or invest.
The amount of leverage provided will certainly vary by broker and level of experience.
The amount loaned to the investor will be subject to interest or other fees. After all, the broker has no real motivation to hand out free money to clients. As such, providing margin to clients is becoming a bigger source of revenue for brokers.
Europe-based cryptocurrency brokers are known to offer much higher leverage rates than their American rivals. It wouldn’t be uncommon for some traders
Tip #1: Do You Even Need Margin To Trade Cryptocurrency?
Since borrowed capital comes at a cost, many investors or traders can avoid unnecessary fees if they don’t need access to margin or leverage in the first place.
If someone wants to sell part of their stock portfolio to gain exposure to a portfolio of cryptocurrency, there isn’t much of a need for margin.
Tip #2: Use Margin Wisely
It needs to be emphasized that margin is borrowed money so the investor or trader should treat it as if it is their own money. Trading and investing with someone else’s money could deceive novice individuals into thinking they can take unnecessary risks since the money isn’t theirs.
Anyone that can’t respect this basic principle may want to think twice about borrowing funds.
Tip #3: Shop Around For The Right Rates
The growing competitive landscape in the cryptocurrency industry means many brokers are trying to carve out a niche for themselves by specializing in one aspect of the business.
Some brokers cater specifically to day traders looking for access to trade cryptocurrency on margin.
Their margin rates will drastically differ from other brokers that offer rates and features for buy-and-hold investors looking to invest for the longer-term.
Tip #4: Understand The Loss Potential
Cryptocurrency brokers aren’t in the business of deceiving their customers — at least the majority aren’t. The honest brokers will make it abundantly clear to customers that trading cryptocurrency on margin or leverage can result in losses above and beyond the initial investment.
The math behind this statement makes it easy to understand how this is possible.
Suppose an investor deposits $10,000 and is offered a margin rate of 10 times their deposit. The entire $100,000 is invested in a cryptocurrency and one week later it suddenly losses 15% in value.
The position is now worth $85,000, representing a loss of $15,000 to the customer.
Cryptocurrency brokers do make use of advanced and sophisticated risk management tools that liquidate a position when it approaches a loss equal to the cash deposit.
But in many cases due to liquidity issues in a fast-moving market, it may not be possible to get out of a position without extra losses.
In this case, the customer would need to pay the broker an additional $5,000 to cover their losses. Brokers can and will use all legal measures at their disposal to recover the funds they are rightfully entitled to.
Anyone who will stress about this very realistic and common scenario should avoid buying cryptocurrency on margin in the first place.
Tip #5: Please, Please Don’t Take Out A Second Loan
Investors that want to take out a second mortgage on their homes or secure a large line of credit to buy cryptocurrency on extreme margin are discouraged from doing so under all circumstances.
As hard as it may be for many investors to owe a cryptocurrency broker an extra $5,000 because of a large loss, it is a whole different scenario if an investor owes a bank $50,000 or more because of losses.
When it comes to legal recourse, banks have what seems like unlimited resources at their disposal to recover money owed to them.
Joseph Borg is the President of the North American Securities Administrators Association, an organization devoted to investor protection.
His comments in 2018 give the impression he is a friend of the cryptocurrency industry and recognizes an individual’s rights to invest their money how they see fit.
“It’s not the first time mania such as bitcoin has reached out and touched folks to the point where they’re like ‘I gotta get in, I gotta get in—let me go tap my line of credit in my bank,’” said Borg. “It’s the same thing that got people in trouble in ’06 and ’07.”
Conclusion: Use Common Sense
Like everything else in life, common sense more often than note prevails. If buying cryptocurrency on margin is something that would cause undue stress then by all means avoid all temptations.
But sophisticated traders and investors with many years of experience buying stock or other asset classes on margin have no reason not to do the same with cryptocurrency.
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