Buying Bitcoin On a Margin: Winning Big or Losing Your Shirt

On November 29 there were quite a few bitcoin market spikes, and so-called flash crashes on exchanges, according to traders on social media and forums. One particular group of traders that really felt the storm when markets got turbulent were margin traders on exchanges like Bitfinex. In fact, if one were to visit the Reddit forum /r/bitfinex that day, they would see a whole bunch of angry customers who were burned buying bitcoin on a margin.

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Buying Bitcoin On a Margin

Many people trade bitcoin on exchanges and understand how to place a buy or sell order and interact with the trading platform’s operations. However, there are other methods of exchange on cryptocurrency trading platforms and brokerage services called ‘margin trading.’ Buying on a margin is borrowing money from the exchange, so you can obtain a profit in the short term by placing a long or short bet on a specific digital asset with loaned capital.

Margin trading is far riskier than basic trading. Essentially, individuals with a limited amount of crypto-capital can add leverage to their base investment. For instance, if you hold two bitcoins the exchange allows you to open a margin position with leverage (loaned money) based on your initial capital. Exchanges like Bitfinex, Bitmex, Kraken, Bittrex, and Poloniex all offer these types of trades, and some of them allow other customers to provide the lending material. The risk a margin trader deals with is that they are gambling with loaned money and the market may not follow their predictions.

Long and Short, Liquidations, and Stop-Loss Orders

As mentioned above traders who buy cryptocurrency on a margin place positions (bets) called “long or short.” A long trade is started by purchasing the digital asset and hoping to sell it for a higher price in the future. Short trades consist of selling a digital asset and betting the price will drop in the future. The net amount is the market’s value either bought or sold; so if you play a short position, your base values will be negative. Cryptocurrency exchanges use the estimated highest bid for long positions and the lowest values to realize short bets which in turn can lead to ‘liquidation.’

A liquidated margin account means if your current balance is $1000 USD and a loss on the position is -$500 then you have lost half of your money. If the loss on the position is way lower, at say -$1200, your position will be forced liquidated at that market price. However, traders can utilize a tool called a ‘stop-loss order.’ This means you tell the exchange you want to sell the digital asset when it reaches an approximate price. The idea is to save someone’s assets from being forced liquidated when the market dips or for rare occasions like ‘flash crashes.’ However, a good majority of traders traditionally use the stop-loss order setting for long positions. Traders often forget to utilize this tool in short positions, and this is when traders usually get burned.

Traders Getting Burned

In addition to stop-loss orders, cryptocurrency exchanges use what’s called a ‘margin call.’ This is when a trading platform notifies the borrower when the user’s contract value goes below a specific price. All bitcoin exchanges have different formulas to how they execute margin call levels. Even though these trading safety nets are in place, traders still complain of issues during ‘flash crashes.’

“Margin call level is the margin level at which you are in danger of having some of your positions forcibly closed (or “liquidated”),” explains the San Francisco based exchange Kraken. “If this happens, your positions will be closed in the order they were created, first to last — The number of positions closed is at our discretion — we may close all your positions or only enough to get your margin level above 100%.”

Margin call guidelines for the exchange Bitfinex are as follows:

When a position is force-liquidated, the system places a limit order at the zero-equity price (rather than simply executing a market order). We do this to prevent a liquidated position creating a negative account balance for the user due to slippage during highly volatile market periods.

There was a lot of complaining about margin traders getting ‘burned’ the day many digital assets reached new all-time highs. Take for instance this post on the Reddit forum /r/btc from an individual who was liquidated for $200K worth of funds on Bitfinex.

“Forgive me, but English is not my first language,” explains the post. “I see that Bitfinex has been having a lot of issues and I checked the website while bitcoin’s price was falling. As the page was loading in an instant, my account went from about $180,000 to minus -$20,000.”

I don’t know what to do — I tried to contact support, but no one has responded to me and now I can’t even log into my account at all.

Who Is to Blame For Crypto-Flash Crashes?

Angriness has been the sentiment from margin traders on Bitfinex and other exchanges this week. Traders are not too pleased with the multitude of exchanges that had severe operational issues on November 29. Traders say they could not access their accounts and stop liquidations before it was too late. Looking at posts on /r/bitfinex and all across Twitter, it is safe to say traders lost hundreds of thousands of dollars that day.

The question, however, is — Who is to blame for the losses if traders did not set their stop-loss orders? Is it the trading platform’s fault for not being able to maintain consistent operations? Whatever the case may be margin traders can ‘lose their shirt’ if they are not careful with this type of trading method.

What do you think about cryptocurrency margin trading? Do you margin trade on exchanges? Let us know your thoughts in the comments below.

Images via Shutterstock, and Bitfinex.

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