You can potentially make big profits from the price fluctuation in the crypto markets through margin trading. Indeed, many have grown their worth significantly using this as one of their ways of investing. Margin trading enables you to buy, and HODL crypto assets whose prices you anticipate will rise even when you don't have significant capital to invest.
Every time you see an opportunity, you go to one of the many crypto exchanges that support margin trading, borrow some money, buy the crypto asset and wait. The moment its price hits a favorable high, you sell, pay back the loan and keep the profits. Indeed, some exchanges can give you a loan that is as much as three times your deposit with them.
It is possible, though, for things to go wrong. There are risks involved with taking a loan from an exchange to trade crypto assets.
So, what are the risks of crypto margin trading?
The following are four risks of crypto margin trading that you should be aware of and prepared to mitigate.
1.Highly unpredictable price movements
The opportunity in trading crypto assets is found in their price volatility. Over time, and with some effort, you can learn how to predict crypto price trends and capitalize on it. With that stated, hardly anyone can be 100% sure which side the price of a crypto asset will move and how far it can go.
It is always possible that the price will go in the opposite direction from the one you hoped for or predicted. When that happens, the value of the assets you hold can erode so much that the exchange has to liquidate you and also charge you extra fees.
You must have an awareness of this outcome in mind before you borrow from an exchange to trade. It is also a reason why you should borrow only what you can comfortably afford to repay.
2. Untrustworthy exchanges
The crypto space is, to some extent, still the wild west of the financial sector. Anybody can set up an exchange as long as they have the capital to do it. This is not actually a bad thing, but it calls for you as an investor to be a lot more vigilant and to do some due diligence. Independent audits are still a new thing in the crypto markets, and regulators are still learning how everything works.
It is important to note that many exchanges have proven their credibility and trustworthiness over the years. But still, you can easily become a victim of a few unscrupulous ones. They may show you the wrong exchange rates or worse even shut down, and the founders disappear.
It is important to deal with only exchanges whose foundation you understand. While doing due diligence is not 100% foolproof, it significantly reduces the risk of losing your money.
You should know that when you borrow from an exchange for margin trading, the money is in their full control.
3. An exchange being hacked
Hackers are always busy trying to get into exchange wallets. The exchanges are a perfect target because money stolen (in crypto) cannot be tracked. Over the years, exchanges have lost hundreds of million dollars. While some of the exchanges hit have managed to compensate users, others have not, with Mt Gox being the most known case.
When looking for an exchange on which to trade on, you need to do some research on what security mechanism they have put in place to safeguard assets. You should find out whether they use cold storage to hold the crypto assets. A cold storage is a wallet that is not linked or connected to the Internet, making it difficult for hackers to access it remotely.
Another measure that could be in place is the use of multisigs, meaning that for a transaction from the exchange to be validated, more than one digital signatures have to be appended. It also gives confidence if an exchange has a strong security team working for it. Of course, track records can also help you decide the secure enough exchange to work with.
4. High or hidden fees
It is not unlikely that you can make what seems to be an excellent return from a trade on an exchange only for it to be wiped out by a list of fees and interests. You should be aware of all the costs and interests you are expected to pay on an exchange for your margin trading.
And some of these fees are not the fault of the exchanges. For example, network transaction fees (or gas as it is known on the Ethereum network) can take a significant chunk of your profits. It is important to be aware of these fees and how to manage them. For example, always check what the network is charging you before sending a transaction.
You may choose to use an exchange with lower fees and interests or adjust the fees where possible when sending or converting currencies.
This article is not written to dissuade you from doing margin trading. It is meant to help you make smarter decisions as you seek to profit from the opportunities in the crypto market, including margin trading.