Margin in Crypto: Definition, Methods, and Examples

Margin is a portion of a trader's own capital that is deposited as collateral when using leverage. For example, if a position is opened for $1,000 with 1:5 leverage, the trader's own funds will be $200, and the remaining $800 will be borrowed.

In essence, margin acts as an insurance buffer for the exchange. If the market moves against the trader's position and losses become significant, a margin call is triggered, requiring the trader to increase collateral or close the order. If the situation continues to deteriorate, the system may liquidate the position entirely to cover the debt.

Source: Forklog.com

How margin trading works

Margin trading is a trading method in which a trader uses not only their own funds but also borrowed capital. This approach allows traders to profit both when the price of an asset rises and when it falls, increasing the potential return on a trade.

In the cryptocurrency market, digital assets such as Bitcoin, Ethereum, and many other tokens are used as trading instruments. To gain access to borrowed funds, a trader deposits a margin — a portion of their own money that serves as collateral and guarantees the fulfillment of obligations to the exchange or lender. An interest commission is charged for the use of borrowed capital, the amount of which depends on the conditions of the platform and the specific asset.

The use of margin trading opens up the possibility of applying a variety of trading strategies and making a profit from a larger amount of capital than is available on the balance sheet. However, increased profit potential is accompanied by increased risks.

From a technical standpoint, margin trading means that the trader is actually buying or selling real assets on the spot market, rather than their derivatives. In other words, the participant actually owns the coins they are buying or selling.

In contrast, futures contracts are derivative instruments based on the value of the underlying asset. They do not involve actual ownership of the cryptocurrency; transactions are conducted on a separate market where traders trade obligations rather than the coins themselves.

Source: Forklog.com

How margin trading works in practice

Let's imagine that a trader has 1,000 USDT in their account. When using 1:5 leverage, the amount of funds available for trading increases fivefold to 5,000 USDT. Of this amount, 1,000 USDT is the trader's own capital, and the remaining 4,000 USDT is provided by the exchange as a loan.

Example with price increase:

Let's say a trader opens a long position for 5,000 USDT, buying approximately 5 BTC. After some time, the price of Bitcoin rises by 10%. Now each BTC is worth 1,100 USDT.

If the trader closes the trade by selling the assets at the new price, the total amount of the position will be 5,500 USDT. After returning the 4,000 USDT loan, they are left with 1,500 USDT, of which 1,000 USDT is the initial capital and 500 USDT is the net profit. Thus, the return was +50% on the initial deposit with a market growth of only 10%.

Example with a price drop:

Now let's consider the opposite situation. The price of BTC drops by 5%, and now 1 BTC costs 950 USDT. Accordingly, the total value of the position of 5 BTC is 4750 USDT.

If the trader decides to close the trade at the current price, they will receive 4,750 USDT, of which 4,000 USDT will go towards repaying the loan, and the remaining 750 USDT will remain in the account. This means that the loss will be 250 USDT, or minus 25% of the initial amount, even though the price of the asset has only decreased by 5%.

This example is provided for illustrative purposes. On a real exchange, additional fees are charged for opening and closing trades, as well as for using borrowed funds.

What is a margin call and position liquidation

A margin call and position liquidation (liquidation or forced liquidation) are protective tools that exchanges use to prevent traders from incurring debts and reduce the risk of losses for creditors.

A margin call is a notification from a broker or trading platform that additional funds are required to maintain open positions. This situation arises when the margin level falls to a critical level and the current funds are no longer sufficient to cover the transaction. The threshold value is determined individually for each trading pair and depends on market liquidity, transaction volume, and leverage level.

If the trader does not respond to the warning and does not increase the margin, the system may proceed to the next stage — liquidation.

Liquidation is the forced closure of a position when losses approach the amount of collateral deposited.

When the risk zone is reached, the user receives a notification in the exchange interface or by email with a proposal to replenish the balance. If this does not happen and the price continues to move against the position, the exchange automatically closes the trade to avoid debt.

The trader has the option to close the trade early. This can be done manually or with a stop-loss order. In this case, they will only lose part of the margin, retaining control of the situation and avoiding complete liquidation of the position.

Advantages and risks of margin trading

The main advantage of margin trading is the ability to significantly increase potential profits by using borrowed funds. Thanks to leverage, traders gain access to larger positions than their own capital would allow, which makes this strategy particularly attractive in volatile markets.

Margin trading also helps diversify your investment portfolio. With a small deposit, traders can open several trades at once and spread the risk across different assets. Another advantage is speed. Having a margin account allows you to quickly open new positions without having to deposit a large amount of money in advance.

However, this approach also has its drawbacks. The use of leverage increases not only profits but also losses. Unlike spot trading, losses here can exceed the initial investment, which is why margin trading is considered a high-risk instrument. Even a small price movement against an open position can lead to partial or complete liquidation.

To avoid significant losses, traders apply strict risk management rules. They set stop-limit orders, control the size of the position, and calculate in advance the optimal ratio between their own funds and borrowed capital.

A limit stop order combines a stop trigger and a limit order. Limit stop orders allow you to set the desired minimum profit or the maximum amount you are willing to spend or lose in a trade.

This approach allows you to use margin trading effectively and with minimal risk.

In conclusion on Margin in Crypto Trading

Beginners are advised to start with small amounts, follow risk management principles, and avoid excessive leverage. With a competent approach, clear planning, and regular training, margin trading can become a useful element of an overall investment strategy in the dynamic cryptocurrency market.

It is important to remember that successful trading requires flexibility, self-education, and adaptation to changing market conditions. The cryptocurrency market is highly volatile, and only continuous development and the ability to respond quickly to changes will help achieve stable results.

Whether you are looking to diversify your portfolio, strengthen your market position, or take advantage of short-term opportunities, margin trading can be an effective tool for achieving your financial goals in the rapidly evolving world of digital assets.

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Cryptocurrency market operates 24/7/365 without interruptions. Before investing, always do your own research and evaluate risks. Nothing from the aforementioned in this article constitutes financial advice or investment recommendation. Content provided «as is», all claims are verified with third-parties and relevant in-house and external experts. Use of this content for AI training purposes is strictly prohibited.