Some people don’t invest because they have limited capital. But do you know that there is an option called “Margin Lending” that allows you to invest? If you ask retail investors how they invest with little money, you will find that they are investing by lending funds from the broker.
However, the risks involved in margin lending is high, so it’s better to avoid going for it if you are a beginner. More importantly, if you are interested in cryptocurrencies, then understand the concept of margin lending before you take money from your broker.
Margin Lending in Crypto
How do you take a loan from a bank or any lender? You keep some of your property as collateral to get the loan, right? Similarly, margin lending is a similar concept used in the investment space. Here you bring money from someone by keeping your holdings as collateral in the same exchange. It’s also the same in the crypto exchanges.
It may sound interesting, but you need to understand it properly because they come with some potential risks. Note, all crypto exchanges don’t provide you a margin for investing in cryptocurrencies. Moreover, crypto exchanges don’t provide lending for every type of cryptocurrency. Learn about Bitcoin investing by visit here at this page.
Before you take margin from any exchange, you need to understand what crypto margin lending is?
How Crypto Margin Lending Works?
Crypto margin lending works via crypto exchanges. Crypto exchanges connect two parties; (1) who wants to borrow cryptocurrency and get more exposure, with (2) who have holdings of cryptocurrencies but they want to earn interest on their holdings.
So, the crypto exchange offers options to the borrowers to make deals with lenders by keeping their shares or coins as collateral. The margin varies between 1x to 100x, and the crypto exchange decides it.
If the borrower fails to cover the margin limit, the exchange ensures that the lender gets back all their lending by liquidating the collateral of the borrower. The exchange uses the Loan to Value ratio to calculate the margin limit. The margin limit is generally 70%, but the limit can be adjusted.
The following formula calculates the loan to value ratio or simply LVR:
LVR= loan amount/ total portfolio value.
Now, you can understand the LVR through a simple example. Assume that you hold different cryptocurrencies worth $10,000. Now, you want to borrow $5,000 from your exchange, and the collateral limit is 70%.
If you borrow more money, your LVR will grow, and if the value of any of your holdings goes down, the LVR will also grow up. So, you have these two factors to consider while calculating the LVR. So, when the total value falls below your maximum margin limit, there will be a margin call. Now, let’s know what a margin call is?
It’s a notification that you get when your margin limit is approaching the maximum limit. However, you don’t get any margin call in crypto investment; your total funds will be sold once the maximum limit reaches. Therefore, you need to be careful before opting for margin lending while investing in cryptocurrencies. Read on to know the risks involved in crypto margin lending.
Crypto Margin Lending Risks
Usually, margin lending has a very low risk on the lender, but it’s riskier for the borrower. The only risk is a lender cannot contact the borrower to lower the LVR. On the other hand, the borrower will lose more than the original investment if the market goes down.
Now that you understand margin lending ensure that you have enough understanding and can afford the risk. If you are starting with cryptocurrency trading, it’s better to avoid using margin lending. Once you are good at managing your fund, you can go for margin lending though I recommend avoiding them.