Margin trading is a method used to amplify trading results and maximize profits from successful trades. It consists of trading with borrowed capital in order to increase your exposure to a market beyond what you could using only your own funds.
Because it can increase both your gains and losses from market swings, margin trading is considered complex and risky. In this article, you will learn basic concepts in margin trading, how it works, and the best platforms for margin trading in DeFi.
Collateral is the minimum deposit needed to secure and repay a loan. The more collateral you put down, the more you can borrow.
Margin is the capital borrowed from a broker to purchase an investment. It is the difference between the total value of an investment and the loan amount.
Leverage is a measure of how much extra buying power you gain from borrowing funds to trade. It is usually expressed as a multiplier (2x, 3x, etc.)
Liquidation happens when your position is automatically closed because its unrealized value drops below your collateral. The liquidation ensures that you don’t lose more than your collateral; therefore, loans are at high risk of liquidation when there is too much borrowed and too little in collateral.
The idea behind margin trading is actually quite simple: you borrow funds from an exchange or lending platform to invest more funds than you currently have in your account. That allows you to open larger positions than you could without the loan, maximizing your returns in case of profit or loss. In other words, you use borrowed funds to leverage your account balance, taking on extra risk for the possibility of a larger reward.
This process may vary from one platform to another, but to do margin trading, you must usually provide an initial deposit to open a position called initial margin. In crypto exchanges or lending platforms, this capital is usually held by the platform as collateral. To keep your position open, you may also have to hold a certain amount of capital in your account. The amount you’re able to leverage depends on the rules imposed by the platform you use and your initial deposit, but in crypto markets, it can range from 2x to 100x the value of your unleveraged position.
Here is an example: with margin trading, you can buy $10,000 worth of Ethereum with only $5,000 (by borrowing 50% or leveraging 2:1 or 2x). That means you borrow the $5,000 you don’t have from a lender, be that an exchange or lending platform, to whom you may or not pay a fee (interest on the money borrowed). This increases your potential gain (e.g., 5% returns over $10,000 worth of ETH instead of only $5,000), but it also increases potential loss (e.g., 5% loss over $10,000 worth of ETH instead of $5,000). And if an interest fee is charged (this is usually the case), it will accumulate and be payable for as long as your position remains open.
One last aspect to take into account is how margin trading can affect transaction costs. When fees are charged over the full amount traded and not only the initial margin, your position can end up being liquidated because of your inability to cover transaction costs.
dYdX is a well-known decentralized margin trading platform built on Ethereum and powered by smart contracts. The protocol goes beyond margin trading and provides decentralized peer-to-peer shorting, lending, and options trading of any Ethereum-based token. Users can trade with up to 5x leverage and use their own funds as collateral. The platform offers 3 trading pairs: BTC-USD, ETH-USD, and LINK-USD. Traders also have to pay interest fees and transaction costs.
Users can choose between using isolated margin and cross margin. Isolated margin is when you “isolate” a particular amount of assets as a part of a trade at a specific leverage. If there is a liquidation, the losses are kept to your isolated position. On the other hand, cross margin utilizes all the assets you have in your account and also takes into account the combined positions in your account when defining leverage and limits.
DDEX is an advanced decentralized margin exchange based on the open Hydro protocol (a “fork” of the 0x protocol). Users can create leveraged margin positions (up to 5x) for the following pairs: ETH/DAI, ETH/USDT, ETH/USDC, WBTC/USDT, and HBTC/USDT. A "Pro Mode" is also available where margin traders can place market, limit, and stop-limit orders as well as adjust existing positions.
DDEX also allows you to borrow or lend funds with interest rates for both borrowers and lenders algorithmically set based on supply and demand. Most of the interest generated is given to lenders who supply assets to its lending pools. The required collateral rates for borrowers vary depending on the amount of leverage used. Loans are liquidated if their collateral rate falls below 110%.
Morpher DEX is powered by a set of smart contracts built on Ethereum and allows you to trade over 700 stocks, commodities, currencies, and other crypto. You can go long or short any market with up to 10x leverage, perfect liquidity, and no commissions. The platform is unique because the counterparty to all trades is not another user but a smart contract.
With all Morpher trades, you can never lose more than what you invest. The margin interest (a daily, non-compounding fee of 0.015% net exposure multiplied by the leverage selected) is deducted from the value of your position. This is beneficial in two ways: you don’t need to maintain any balance to cover the margin interest (because you already provided it when you opened the position), and if your position liquidates, there are no fees left to pay.
Morpher DEX was created using the Morpher protocol, which already has over 40,000 active users every month and executes thousands of trades per day.
Margin trading can be extremely beneficial for traders who want to maximize their gains, but it comes with associated risks. DeFi platforms have been working to make this complex trading feature (formerly reserved to institutional investors) accessible to anyone, but it’s important for beginners to carefully study the different platforms and how they work before choosing one. Since there is a lot of innovation happening in DeFi, margin trading will differ between platforms.
Please note that the information above is for information purposes only and is not financial advice. You should do your own research when trading and investing.
This article was written by the team at the Morpher Labs.