Disclaimer: This is a guest post by Patricia Dixon
There is always strength in numbers, or so the old saying goes. Its veracity remains undisputed (partially debatable) when applied to any facet of life, be it politics, history, or finance. Today, in an increasingly digital world, the adage is finding application in the realm of cryptocurrency exchanges.
A cryptocurrency exchange is nothing but a platform that facilitates the purchase and sale of digital currencies. According to CoinMarketCap, exchanges play a very crucial role in popularizing and developing cryptocurrencies. This is evinced by a massive $322 billion capitalization this market boasts and is further supplemented with 24-hour trading volumes touching $67.3 billion.
Cryptocurrency exchange software is continuously being updated to improve engagement and entice more users. One method involves introducing new trading options. Presently, models such as market orders, limit orders, and stop orders are prominent. They match buyers with sellers faster and help users set predefined parameters for executing transactions. However, the popularity of these options pales out in comparison to a relatively new model – Margin Trading.
Understanding The Term
To state simply, margin trading refers to a scenario where an individual places orders using funds borrowed from a broker. Usually, there is a limit to the line of credit extended, and the borrower has to repay the loan along with interest within a stipulated time frame.
How Does It Work?
Margin trading enables individuals to place larger orders and potentially earn a profit in case the invested cryptocurrency performs well. The borrowed funds help the individual in this pursuit.
Let us look at an example. Alice is a crypto trader and has $5000 in her account. Based on market trend, she believes that the Bitcoin which is currently priced at $2500 will increase in value over the next couple of days. She can only purchase 2 BTC with her funds, but Alice wants to invest more. Hence, she approaches Bob, a broker. He agrees to lend her an additional $10,000 and expects $1000 as interest. Using these borrowed funds, Alice places an order for 6 BTC. Over the next 4 days, the price of each Bitcoin rises to $5000! Thus, the value of Alice’s investment portfolio has grown to $30000. After she repays Bob $11000, she is left with $19000, of which $14000 is her profit. Thus, by using margin trading and her vast market expertise, Alice was able to reap substantial rewards.
What Are The Downsides?
However, margin trading is not everyone’s cup of tea. It should be noted that irrespective of a profit or loss, the borrower has to return the funds to the lender along with interest. Harking back to the above example, imagine a scenario where the Bitcoin’s value drops to $1250. She would still be liable to repay Bob’s $11000. This would leave her with a total loss of -$6000.
Thus, experts advise that only investors with substantial market acumen should participate in margin trading. This advice is even more significant when viewed from the perspective of a cryptocurrency investor. With constant price fluctuations and no proper regulation in place, it is very easy for greenhorns to lose money and enter debt traps.
In light of several incidents, many exchanges are taking steps to address this problem head-on. They have included disclaimers as well as content to educate new users against the potential harms.
With the market capitalization of cryptocurrencies predicted to hit $1 trillion, things are looking upbeat. This makes margin trading a go-to option for many traders. Moreover, as more and more information about cryptocurrencies is pouring in, the time taken to master this craft is significantly reducing. Finally, platforms are introducing strict limitations and are developing simulation games to teach new users about cryptocurrency exchanges.
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