Margin Trading

The year is 2021. DeFi is booming. Loan and yield farming platforms are incredibly popular: Billions of dollars circulate in them. But, DeFi also has its margin and derivatives platforms. First-time investors typically stay far away from these platforms – which they should. Nevertheless, it is important to talk about these platforms and explain how they work. So, In this article, the focus is on margin trading and it’s DeFi platforms.

Margin trading

In essence, margin trading is investing with borrowed money. It allows you to buy more financial products (such as stocks, options or futures) than you have available in money. The use of this borrowed money is also called leverage. This ensures that profit results are increased and can thus ensure higher returns. However, it also has a bigger risk of larger losses. In margin trading, the user’s portfolio serves as collateral and, when prices are falling, this can lead to a margin call.

How margin trading works

Margin trading, simply put, is leveraged investing. The leverage is determined by the investor. The concept of margin trading is most easily explained with an example:

Let’s say an investor has a wallet with $10.000 of ETH and buys for $15.000 in ETH. In this case, the investor buys $5.000 in ETH above of what he was able to buy with the amount in his wallet. The extra $5.000 in ETH is bought with money borrowed from the broker. So, the investor buys the $5.000 in ETH "on margin" and pays interest on this borrowed amount.

Pros and cons of margin trading

The advantages of margin trading are:

  • It enables investors to take larger positions. Should the investor prove right and the price does indeed move in the right direction, the profits are higher due to the use of leverage.
  • Some financial products, such as USD currencies, are usually not very volatile. The use of margin can ensure that high returns can still be made, although the risks also increase with leverage.

Some of the disadvantages of margin trading are:

  • Using leverage allows results to be magnified. When a trade goes wrong, an investor will therefore have to deal with greater losses.
  • Margin trading ensures that investors may be faced with a so-called margin call, with which they can lose more than their investment. In a margin call, the investor has to add money or close part of his portfolio, because the leverage has become too great in relation to the equity capital. With cash accounts there is no leverage and the maximum loss is therefore limited to the deposit.
  • Like borrowing, the use of margin is not free. The interest 1. depresses the return and 2. it may be flexible. The latter can cause interest costs to fluctuate. Using margin makes the portfolio more volatile. It is therefore advisable when you use margin in your portfolio to keep a close eye on it.

Margin trading DeFi platforms:

There are fewer margin trading platforms in DeFi than "regular" DeFi exchanges. Let's take a look at the 2 best-known DeFi margin trading platforms on the Ethereum blockchain.

dYdX

dYdX is a decentralized trading platform for margin trading in combination with a lending & borrowing marketplace. Lenders and borrowers can gather here and earn interest on an Ethereum (ETH) basis, use loans and leverage on the trading platform. The dYdX trading platform runs on smart contracts, on the Ethereum blockchain without intermediaries. It is a great defi project that works completely transparently. dYdX currently has one of the largest volumes and has a lot of liquidity compared to other decentralized crypto exchanges. Investor will have to deposit collateral before trading.

dYdX supports the following trading features:

  • Spot: Investors can buy and sell currencies “on the spot”. This is the most standard form of investing.
  • Margin: With this feature, investors can use a leverage of 2x to 5x on their spot trade.
  • Perpetuals: For even higher leverage, investors can leverage their investment up to 10x via this feature.

dYdx supports the following currency pairs: ETH-DAI, ETH-USDC, and DAI-USDC. More currency pairs are being added over time. It is also worth to mention that dYdX offers 2 different types of trades: Isolated and Cross. Isolated assigns a specific amount of an asset as margin. Cross utilizes all positive balances in your dYdX Margin Account as margin.

Just like the platforms described in my previous post about lending and borrowing, dYdx also supports traditional lending & borrowing options. Currently, the dYdX Ethereum DEX supports the following digital assets: ETH, DAI and USDC. A loan must be backed by collateral, covering 125% of the loan and must be kept above a minimum of 115%.

Fulcrum

Fulcrum, like dYdX, is a decentralized trading platform. It enables trustless and permisionless transactions, without fees. It sets aside 10% of the accrued interest for the maintenance of the platform and the insurance fund. Fulcrum uses smart contracts, and works on both the Ethereum and Binance blockchain. The platform supports more than 10 cryptocurrencies for loans, and dozens of currency pairs for margin trading. Like dYdX, the investor will have to deposit collateral before a leveraged position can be taken.

Fulcrum only supports the margin trading feature, where the leverage can be increased up to 5x. No spot or perpetuals tradings can be performed on this platform.

As mentioned earlier, Fulcrum also supports traditional lending & borrowing features with a wide range of cryptocurrencies. The lending rates of both fulcrum and dYdX are higher than those of Aave and Compound. What I personally like about Fulcrum is its user-friendliness, thanks to its minimalistic yet colorful interface.

Conclusion

Margin trading is a high risk/reward game which should only be exercised by experienced investors. Both fulcrum and dYdx are designed to be robust yet simple platforms for margin trading and lending that takes full advantage of the benefits of smart contracts and decentralization.