Decentralized finance started back in 2008 when the first Blockchain was used as the distributed ledger. It was until August 2018 when for the first time Ethereum developers choose a name as Defi or Decentralized Finance. But what is Defi?
Defi technology replaces the control of centralized banks and financial institutions on money, financial services, and financial products. Consumers can hold their money in a secure digital wallet instead of keeping it in a bank. The technology ensures that you can transfer funds within a few seconds without the involvement of a third party like a bank.
Important terms to know for margin trading in crypto space
Collateral: Collateral is the minimum deposit required to secure a loan. The lender accepts the collateral as a security for a loan. If the borrower fails to repay the loan, the lender can sell the collateral to overcome some losses.
Leverage: This denotes the buying power you gain after borrowing funds. It is usually expressed in the form of multipliers like 2X, 3X, etc.
Stable coins: Stable coins are those digital assets whose value doesn’t fluctuate much like other crypto coins. They are backed by real-world assets like fiat currency, gold, or other cryptocurrencies. For example Tether, Binance USD, etc.
Before we move on to margin trading in Defi let’s understand what is margin trading.
What is margin trading?
Suppose you want to buy a stock whose price is high enough that you can’t afford it with your portfolio. In that case, you can borrow money from an exchange or lending platform to invest in that pricey stock. This way you can have a larger position than you could have without the loan.
To implement margin trading, you need to provide an initial deposit to open your position called initial margin. This could be in the form of cash or any collateral.
The initial margin varies from one institution to another. In the USA the initial margin requirement set by the Federal Reserve Board’s Regulation is 50%.
Margin trading in crypto space
In the crypto space, you need to hold a minimum amount of capital in your account in the lending platform. Then you can use your collateral to borrow stable coins. The stable coins can be used further to trade other crypto coins like Ethereum. You need to pay interest on the money borrowed. Let’s understand this with an example.
For example, you have 20000$ worth of Ethereum(ETH) but want to multiply them by some folds. You can deposit your ETH to borrow stable coins like USDC. Suppose you get $10000 worth of USDC, you can USDC trade for another $10000 ETH. Thus now you will be exposed to 30000$ worth of ETH. So the net leverage on your trade would be 1.5X. The maximum allowable leverage however varies from one platform to another.
The potential gain may increase with the growth of Ethereum over time. Suppose you will gain a 10% return in your ETH. Instead of getting returns on $5000 worth of ETH, now you will get returns on $10000 worth of ETH.
Instead of gains, you may lose 10% or more of your accumulated ETH. Adding to that the interest on the borrowed amount will also accumulate over time as long as you keep your positions open. Thus there is an added risk on the leverage amount.
Several platforms allow margin trading in the crypto space. DYdX is perhaps the most popular decentralized margin trading platform. DYdX allows traders to leverage up to 5x. Different platforms have different leverage limits. Apart from DYdX, there are other platforms like DDEX and Morpher DEX. Each of these platforms has its separate criteria.
Conclusion
Margin trading is an exciting facility where traders with good knowledge may maximize their gains. But it also comes with associated risks. With many starts ups coming up, margin trading in Defi would be more accessible in the coming days. However, for beginners, it becomes extremely important that they research margin trading and the associated platforms since it differs from one platform to another.