Margin Trading, also known as Leverage Trading, is the use of borrowed capital to invest in cryptocurrency. If you want to deal with cryptocurrency, leverage trading is the way to go. It enables you to borrow capital from brokers in order to increase your purchasing capacity and offer higher profits. In simple terms, an investor or trader borrows funds to increase his exposure to a specific type of asset, project, or instrument beyond what would be possible if he relied solely on his own capital. Typically, leverage allows investors to multiply their purchasing power in the market.
Leverage is applied in multiples of the trader's capital invested, such as 2x, 5x, or higher, and the broker lends this amount of money to the trader at the fixed ratio. Leverage can be used to buy (long) or sell (short) positions. It is important to note that both losses and profits will be multiplied.
Leveraging In Crypto Trading
Leverage is one of the most important and widely used features in cryptoasset trading. Trading with leverages became increasingly popular shortly after the establishment of centralized exchanges, despite the fact that the crypto market is volatile. The stock market gave an insight into how the crypto market could carry out leverage trading.
Traders use leverage, just like in the traditional stock market, to either borrow money to increase their purchasing power or to exploit various types of financial derivatives, such as futures and options.
Assume you want to invest $1,000 in Apple stock at a leverage ratio of one to ten. The margin will be 10%, which means you'll need to invest $100. If the current share price of Apple is $136, you will receive 7.35 Apple shares. It’s similar with crypto trading.
In crypto margin trading, you can purchase $10,000 worth of Ethereum for $5,000. (by borrowing 50 percent or leveraging 2:1 or 2x). That is, you borrow the $5,000 you lack from a lender, whether an exchange or a lending platform, for which you may or may not pay a fee (interest on the money borrowed). This increases your potential gain (e.g., 5% returns on $10,000 of ETH instead of $5,000), but it also increases your potential loss (e.g., 5% loss on $10,000 of ETH instead of $5,000). And, if an interest fee is charged, it will accrue and be payable for the duration of your open position.
On a platform like dYdX, users have the option of using isolated margin or cross margin. Isolated margin occurs when a specific amount of assets is "isolated" as part of a trade at a specific leverage. If a liquidation occurs, the losses are limited to your isolated position. Cross margin, on the other hand, uses all of the assets in your account and also considers the combined positions in your account when defining leverage and limits.
The DeFi Pulse Index Leverage Trading
The DeFi Pulse Index, launched in September 2020, includes the ten most popular DeFi tokens available on Ethereum: LEND, YFI, COMP, SNX, MKR, REN, KNC, LRC, BAL, and REPv2.
Instead of purchasing all of these DeFi tokens and managing your own portfolio, you can simply purchase a single ERC-20 token that provides exposure to all ten tokens. The token is rebalanced on a monthly basis to reflect the current state of the market. The token can be used to hedge the market or as collateral on lending platforms like Aave or Compound, as well as yield farming protocols.
Balancer is one of the most popular products on the index. They recently began offering a unique solution for traders struggling to pay high gas fees thanks to its integration with Gnosis protocol’s Cowswap. Trading ERC-20’s on Balancer’s DEX costs a fraction of transaction fees its competitors like Uniswap and Sushiswap
Fuse created by Rari Capital, like Aave and Compound, is based on lending and borrowing pools where users can supply assets to earn interest while other users borrow those assets.
All assets in Aave and Compound are combined into a single market and managed through governance; Fuse takes a different approach by introducing permissionless pools. Anyone can use this to set up their own isolated money markets. Because the pool is isolated, the pool creator can choose any assets, oracle, interest rate model, and so on.
Risk Of Creating Position
People frequently purchase leveraged tokens without fully comprehending how they work. There are a few risks you should know before you buy to avoid making a bad investment.
- Smart contract risk:
Whenever you interact with a smart contract, there is always the risk of exploits that can jeopardize your funds. Most credible platforms conduct security audits, which are critical for getting an outside perspective on the code to ensure that everything is working as it should and that there are no edge cases, overflows, or other issues that hackers can exploit.
- Liquidation Risk:
If you use a CDP, there is always the possibility of liquidation if the value of your collateral falls and you exceed your collateral ratio.
Volatility or the negative impact of volatility on the investment, is one of the most significant risks of leveraged tokens. A comparison is the best way to grasp this concept.
Assume you want to buy Bitcoin and decide to spend $100 on it. After one day, the price has risen by 10%, and your investment is now worth $110. However, the price drops by 10% the next day, resulting in a $11 decrease. Your investment is worth $99.
Tips To Maintain Position
- Pick carefully:
As with any investment, proper due diligence should be performed before purchasing a new asset. This is especially true when purchasing on margin. Consider instruments with strong fundamentals and a track record of long-term growth. Don't follow the crowd and buy the latest hot stock or cryptocurrency.
- Test on a small scale:
What better way to understand and succeed with margin than to start with it? Begin investing on margin to gain an understanding of the risks and costs involved, but start small.
- Set a target price: Always remember to set a target price and avoid becoming greedy, even if the asset has been performing well. This applies to both the winning and losing sides; however, make sure to set a limit for how much loss you are willing to accept. Holding on too long is a common trading mistake made by many investors. If you need to save yourself from extreme loss, use a DAO like Coordinape.
DPI is leveraging on the future
Leverages can increase profits while also increasing risks. Different financial products may provide traders with leveraged exposure in very different ways. Leveraged products, particularly in DeFi, may be powered by innovative models and new liquidity solutions not seen in traditional finance.
Margin trading, when used correctly and as part of an overall risk management strategy, can be a very effective tool in your trading toolbox. DPI is the ideal index for anyone interested in leveraging DeFi.