Margin Trading vs Leverage Trading Crypto

MORITZ PUTZHAMMER

16 October 20226 min read

Table of contents

Is margin trading the same as leverage trading? Is margin considered leverage? Can you leverage trade without margin?

Many crypto terms are often used interchangeably, but there can be subtle differences between them. Margin trading and leverage trading is a perfect example. You might think that the two are one in the same, but, as we’ll see in the following article, there are a few fine distinctions to make.

It’s impossible to discuss margin without talking about leverage, and vice versa. Ideally, for leverage trading to work you need to have margin, and for margin trading to work you need leverage. And since both trading strategies come with increased risk exposure, it’s crucial to understand the differences in order to use them advantageously.

Below is a brief overview of both margin trading and leverage trading, including a breakdown of some of the main benefits of each along with a few reminders of what to keep in mind when engaging in margin trading and leverage trading crypto.

What is Margin Trading Crypto?

Crypto margin trading involves using the funds deposited in your trading account as collateral for a loan from the crypto exchange. The loan advance increases your buying power to trade more crypto than you would if you were to use your own capital. To fully understand the nature of margin trading, let’s first examine the concept of margin.

Margin in crypto

Margin is the initial capital you deposit in your trading account. It is the amount that the crypto exchange requires you to deposit in order to actually access margin trading on the platform. If we think of it in very basic terms, you might consider margin as collateral required by the exchange so that they can loan you more funds to increase your trading position.

Let’s say you have $1,000 and want to trade a position worth $5,000. You deposit the $1,000 in your margin account, and the crypto exchange fronts you the additional $4,000. In this case, the $1,000 you deposited is the initial margin. Margin is usually expressed as a ratio, and, in our example, the margin offered by the exchange is 5:1. Note that once you close your position, you pay back the amount borrowed plus the accrued interest.

To avoid your position being liquidated, your account should always be above the maintenance margin, which is simply the minimum amount of capital you need in your account to ensure that your open trades remain active. Otherwise, the exchange will liquidate your position. When you receive an alert that your account has dropped to such an extent that it’s close to the maintenance margin, you can add more funds to your initial margin or sell part of your portfolio to ensure that your account doesn’t drop below the maintenance margin.

What Are the Advantages and Disadvantages of Margin Trading?

Margin trading works by using a loan from the exchange to increase your buying power. The primary objective here is to increase potential returns. Let’s briefly consider some of the benefits and drawbacks.

Advantages of margin trading

  • Higher potential for increased earnings: The increased buying power allows you to open larger positions, potentially increasing your profits if the trade goes in your favor.
  • Portfolio diversification: The increased buying power means you can afford to hold various assets, effectively diversifying your portfolio.
  • Short selling: With margin trading you can go long or short the market, allowing you to profit in both bull and bear markets, unlike spot markets where you can only go long.
  • Lower interests: Although you must repay the margin lent to you, the interest accrued is still much lower than if you were to take out a loan and trade all cash.

Disadvantages of margin trading

  • Amplified losses: The increased buying power also means increased potential losses if the trade doesn’t go your way.
  • Risk of portfolio liquidation: If the market goes against you and your account falls below the maintenance margin, the exchange could liquidate your entire position. Different crypto exchanges and trading platforms have different rules regarding margin trading and violating them will result in liquidation.
  • Risk of margin calls: In a market as volatile as crypto, short-term fluctuations could push your account below the maintenance margin, triggering a margin call. But if you were trading all cash, you could withstand momentary price fluctuations.
  • Interest: You’ll be required to pay interest on the borrowed margin. Although it is significantly lower than in other markets, it’s still a drain on your potential profits as well as an additional cost if your trade runs losses.

What is Leverage Trading Crypto?

Leverage trading involves using a credit facility extended to you by the trading platform to magnify your position, which depends on the capital deposited in your trading account. Leverage is basically a position multiplier. It’s simply a tool that enables you to gain greater market exposure.

One of the most common misconceptions is that leverage trading is similar to taking a loan for trading. Unlike in margin trading where the exchange loans you additional funds, which you must repay with interest, leverage is not a loan and you won’t have anything to repay. The profits you earn from leverage trading are all yours.

Typically, leverage is usually expressed as a ratio or using the “X” to signify the multiplier. For example, a leverage of 10X means you can open a position 10X the value of your initial deposit. Generally, you are free to choose the leverage you want, which can be as low as 2X or as high as 1000X. For example, if you have $1,000 and leverage of 10X, you can open a position worth $10,000. Note that the maximum leverage varies depending on your geographical locale and the crypto exchange that you are using.

What are the Advantages and Disadvantages of Leverage Trading?

The advantages and disadvantages of crypto leverage trading and margin trading are more or less similar.

Advantages of leverage trading

  • Neither interest nor loan repayments: Unlike margin trading, the profits you earn in leverage trading are all yours.
  • The increased market exposure increases the potential for significantly higher profits.
  • Since leverage trading enables you to trade crypto derivatives, it allows you to trade under any market condition. You can trade crypto futures and seamlessly buy or short sell a given crypto.
  • You have the ability to trade different cryptos with limited capital, effectively diversifying your trades.

Disadvantages of leverage trading

  • Magnified losses: Leverage trading also magnifies the potential losses that you can incur. For example, say you’re trading with a leverage of 10X. A slight market fluctuation of, say, 1% loss translates to 10% in your trading account. And given the inherent volatility in the crypto market, your account can easily be wiped out as a consequence.
  • Leverage trading may not be suitable for longer-term traders. Ideally, leverage trading is most suitable for short-term traders, whether you’re an intraday trader or day traders.

Is Trading with Leverage Better?

In a word, yes. But this will depend entirely on your risk appetite and trading style. As we’ve seen, both leverage trading and crypto margin trading allow you to open larger positions than you normally would if you were trading all cash. However, leverage trading offers significantly larger positions than margin trading. As we’ve seen, though, this also comes with a significantly higher downside.

Also, unlike margin trading, leverage trading doesn’t attract any interest payments or loan repayments, meaning that your trading doesn’t come with additional costs.

Can You Leverage Trade Without Margin?

No. Leverage trading and margin are inextricably linked. Margin is the initial capital you deposit in your trading account; this is the amount you use for leverage trading. Margin is a prerequisite for leverage trading. Without it, you cannot access the leverage. A margin account allows you to have increased buying power. Leverage lets you trade bigger positions than the amount of capital in your account.

Remember that leverage is simply a multiplier, an added buying power, to your capital. The key takeaway here is that margin is the capital required to access leverage, and leverage is added buying power to your positions.

Final Thoughts

Even though margin trading and leverage trading are closely interconnected, the two are not interchangeable. Margin trading involves using the capital deposited in your trading account to borrow more funds from the crypto exchange for trading. Leverage trading, on the other hand, involves using a credit facility extended to you by the trading platform to magnify your position. In this case, leverage measures the increase in buying power of your capital, which is the margin you deposited.

Knowing the differences between margin and leverage is crucial before trading. Naturally, crypto margin trading and leverage trading carry risks, and you should always do your own research before deciding on the best option based on your risk tolerance and investing goals.