When it comes to crypto, I would say that most people love the joy or rush of seeing their coins moon. This is especially true when those gains are magnified through borrowing to get those double digit, or possibly even triple digit returns. As exhilarating as that may be, it is not without some risk. Risk and reward always go hand in hand.
In this post, I'll briefly share a story of how my friend lost roughly $900 worth of Bitcoin (worth more now) within a matter of hours because of this. Hopefully we can all learn from my friend's unfortunate event. We all mistakes and learn from them, however, it's much better to learn from other people's mistakes than from our own. My goal of this post is to help prevent you from making the same mistake that my friend had made. If I help prevent even just one person, I'll consider this post a success.
On March 12th earlier this year, the price of Bitcoin nose dived. It went from as high as roughly $7,700 to as low as about $3,700. That's a $4,000 drop (or approximately 50%). My friend who had just started getting into trading at the time was trading on Bitmex.
For those of you who don't know, Bitmex is a Bitcoin derivatives exchange. This is different from other exchanges where you are actually buying and selling Bitcoin in the spot market. Rather than buying or selling actual Bitcoin, this means that you're betting on the price of Bitcoin where your profits and losses are calculated in Bitcoin. You can think of this as like those online casinos where your profit and loss is given to you or taken from you in Bitcoin.
For newer traders, they most likely don't know the difference between trading on a derivatives exchange and a regular exchange and this can be disastrous. So because he wasn't buying actual Bitcoin on Bitmex, this meant that he was trading on margin. This is something that he didn't know or fully understand at the time.
So when he saw that the price of Bitcoin was dropping, he couldn't pass up on a great bargain (so he thought) and immediately laddered in some buy orders in the $6,000 price range without a stop loss in place to minimize his risk. The only problem was that the price kept plummeting well below his buy orders.
Now if he was trading on a spot exchange, this would have been fine. However, this is Bitmex we're talking about, where the whale professionals go to eat little fishes who don't know what they're doing. If you're a seasoned trader, you know exactly where I'm headed with this. Due to my friend's unfamiliarity of how margin trading works, he got liquidated out of his position and lost all of his $900 worth of Bitcoin.
If you're new to crypto or trading, you may be wondering how that's possible. It's very well possible when you're margin trading. Margin trading at its core, is borrowing to leverage your position. Leverage just means that you're magnifying both your gains and losses. This can be awesome if the trade goes your way. However, this can also be devastating if the trade goes against you. If the trade goes against you and the amount you've borrowed exceeds the amount that you've put in as collateral, the exchange will sell your collateral to pay back your loan. This is also known as a margin call or liquidation.
The math behind margin trading and leverage trading can get a bit technical so I made this video to help with that:
Using what you've just learned about margin trading from the above video, this is another video on how borrowing can be dangerous on Compound Finance or any other platform where you borrow crypto from:
This is another video on how this can be dangerous when you're "shorting" or "going short":
I hope that the videos have given you a better idea of what the dangers of borrowing or trading on margin are. This isn't to say that margin trading or borrowing crypto are bad and that you should avoid them. However, what I am saying though is that you should be aware of the risks involved.
I personally used to trade on Bitmex and would leverage my positions only occasionally. I however knew the risks involved prior to entering those trades and had stop limits on them. As a result, I've never been liquidated or margin called before.
I hope that this post has helped you understand what risk you're taking on prior to entering any open position on margin. Again, if I've prevented at least one person from getting liquidated because of this post, I'll be glad about it. I don't want anyone to get liquidated like my friend did due to a lack of understanding of how borrowing works.
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