- Margin trading has grown in popularity in the crypto world in recent years
- Newcomers look at the potential gains and act irresponsibly
- The mass of inexperienced margin traders is causing the market to crash when otherwise it might not
Margin trading is something that is prevalent almost everywhere in the crypto space – from Twitter to most exchanges, the temptation to use collateral to increase your risk and your potential gains is tempting to newcomers, especially when they see others making massive gains. However, this rise in irresponsible margin trading, marked by mass liquidations when the market moves sharply, has exacerbated the already volatile nature of the space and is now impacting those not involved in margin trading.
Beginners in the Driving Seat
Margin trading began in earnest with BitMEX, which was the first site that offered such facilities. Since then many top exchanges and a number of purpose built derivatives platforms have allowed traders to amplify their risk by up to 125x, something that, for good reason, many financial watchdogs have warned users against utilizing.
Margin trading is a bad idea for 99% of the cryptocurrency community because they haven’t acquired the skill or discipline necessary to handle such a volatile and potentially dangerous mechanism. It’s like giving a non-driver an F1 car and expecting them to win at Monza out of the gate. They’re going to crash, hard.
Inexperienced Margin Trading Causing Funding Flushes
Unfortunately it’s all too easy for inexperienced traders to be attracted by the dazzling three-figure gains posted on crypto Twitter and they think they can emulate these wins without any of the trading knowledge or experience. The overwhelming number of these inexperienced margin trading virgins tend to go long rather than short as that’s easier to understand as a concept, but what they don’t realize is that by going long and not managing the trade they are having a negative impact.
An increasing number of margin traders going long and not managing their trades properly results in the funding rate going up, and when funding rates are high across the board it is an almost sure sign that a ‘flush’ is coming. This takes the form of a drop in the Bitcoin price that liquidates many people who were long. Because Bitcoin drops the entire market drops, ruining the setups of everyone else in the market regardless of whether they were margin trading or not, and resetting the funding rate.
Unfortunately for every liquidated margin trader another three come along and replace them, and so the funding rate goes right back up to where it was much quicker than it ever used to. This problem is only going to increase as the space grows, meaning that flash crashes could become more and more common, much to the consternation of the average trader.