Key Takeaways:
- Margin trading is using borrowed funds to pay for a trade. Traders are required to ensure margin requirements are met in their accounts, otherwise forced liquidations could occur.
- Cross margin allows margin balances to be shared across different positions, whereas an isolated margin is a margin assigned to a single position, which cannot be shared across different positions.
- Smart cross margins, offered by some exchanges, including the GEN 3.0 Crypto.com Exchange, allow for margin requirement offsets for positions in opposite directions and across different product types. Potential advantages include lower overall margin requirements and improved capital efficiency.
What Is Margin Trading?
Margin trading refers to using borrowed funds to pay for a trade. The key concepts to understand in margin trading are leverage, margin, collateral, and liquidation.
- Leverage. This refers to the use of borrowed funds to make a trade. For example, if a trader wishes to buy $1,000 worth of Ethereum (ETH) at a leverage factor of 5x (i.e., multiple of 5), they only have to pay $200 themselves, and the remainder ($800) is borrowed from the exchange or trading platform. In other words, the trader borrowed to increase their position by 5x. The value of the account balance based on current market price, minus the borrowed amount, is known as the equity (although different trading platforms may use varying terms to describe this).
- Margin. There are two types of margin requirements: initial margin and maintenance margin. Initial margin is the amount of funds the trader must put in to open the position. Subsequently, because the market price of an asset fluctuates in real-time, so does the equity level. When the equity level drops below a certain threshold (also known as the maintenance margin), the trader will get a margin call. At that point, they have to sell some or all of their position and/or put more of their own funds into the account in order to bring the equity value back up to the maintenance margin requirement level.
- Collateral and Liquidation. The assets that a trader has in their account are used as collateral for the loan. If the trader fails to meet a margin call, the exchange or trading platform can sell the assets (also referred to as liquidation) in the account and use the proceeds to pay down the loan.
Read more about how returns differ in leverage and no-leverage scenarios.
What Is an Isolated Margin?
An isolated margin is a margin assigned to a single position, which cannot be shared across different positions. The main potential advantage of isolated margin is that any margin deficiency or liquidation for a single position will not affect other positions in the portfolio. This might be suitable for a speculative and highly leveraged position that a trader would like to monitor closely and have a higher degree of control over.
What Is a Cross Margin?
In contrast to an isolated margin, a cross margin allows the trader to share margin balances across different positions, so the excess margin (i.e., equity in excess of margin requirement, which typically happens when there is a gain) from one position can be effectively used to cover margin deficiency (i.e., equity below the margin requirement, which typically happens when there is a loss) from another position. The main benefit of a cross margin is that, in some instances, it could potentially help prevent margin calls and forced liquidation of a losing position.
Let’s look at a visual example of cross margins compared to isolated margins:
- There are four positions, one (in ETH) using isolated margin, and the other three (in BTC, CRO, SAND) using cross margin. CRO and SAND have open orders (i.e., the orders have been initiated but not yet completed). These tokens are the assets used as collateral that will be liquidated if margin calls are not met.
- We use total margin here to refer to the total amount of funds the trader has in their account. The used margin is the amount of funds that have been allocated to all positions. ‘Unused/shared margin’ refers to the funds not being used and which can, therefore, in principle, be deployed into any cross margin position that needs it. Note that open (i.e., unfulfilled) orders will also take up funds from total margin. The maintenance margin (MM) is lower than the initial margin (IM), so it is effectively included in the initial margin.
- Subsequently, the ETH and BTC positions experience losses, dropping them below their maintenance margins. Since ETH is an isolated margin position, it cannot use the unused/shared margin available to the BTC, CRO, and SAND positions, so the ETH position is liquidated (i.e., the ETH position is now gone), assuming the margin call is unmet.
- In contrast, since the BTC is a cross margin position, it can use the shared margin available to the BTC, CRO, and SAND positions collectively to replenish its margin and avoid being liquidated.
Advantages of Smart Cross Margins
Smart cross margin allows margin requirement offsets for positions in opposite directions (e.g., long vs short) and across different product types. Examples of product types are spot margin (i.e., using margin to trade in the spot market), futures, and perpetual futures. The key potential benefits of smart cross margin are reduced overall margin requirements and improved capital efficiency for the trader.
- Positions in opposite directions. This refers to long vs short. A long position means buying the asset. A short position means short-selling the asset. They are positions in opposite directions because the long position gains (loses) when the asset price goes up (down) and the short position gains (loses) when the price goes down (up).
- Because the short position gains when the long position loses, for any margin deficiency in the long position, there would be margin excess in the short position. Similarly, since the long position gains when the short position loses, for any margin deficiency in the short position, there would be margin excess in the long position. Smart cross margin recognises these offsetting effects across positions in opposite directions and may therefore allow the trader to enjoy lower margin requirements overall.
- Different product types. Since the same underlying asset can be traded on margin with different product types, then there are opportunities for margin offsets across product types. For example, BTC can be traded long or short, on margin, in the spot market, and in the futures and perpetual futures markets (i.e., the underlying asset in the futures contract is BTC). Smart cross margin recognises these offsetting effects across product types and may allow the trader to enjoy lower margin requirements overall.
- Improved capital efficiency. Due to the lower margin requirements, traders could potentially put their funds to other uses. Funds are not as tied up with margin requirements, so overall portfolio liquidity and flexibility are potentially improved.
Cross Margin Vs Smart Cross Margin Requirements
Let’s take a look at a hypothetical example from the GEN 3.0 Crypto.com Exchange of how smart cross margin could reduce margin requirements. Assume the trader executes the below three hypothetical positions, and that the initial margin requirement is 5% of position value (i.e., used 20x leverage):
- Long 1 BTC Sept-expiry futures contract at price of $60,000
- Long 1 BTC perpetual futures contract at price of $61,500
- Short 2 BTC June-expiry futures contracts at price of $61,000 each
Under cross margin, the initial margin requirement is $12,175. Smart cross margin, however, sums up the margin requirements for the long positions and short positions separately, then uses whichever is larger as the initial margin requirement. In our example, the summed margin requirement for long positions is $6,075; for short positions it’s $6,100. Therefore, the initial margin requirement is $6,100, the larger of the two. This is significantly lower than the initial margin of $12,175 required under cross margin.
Refer to https://crypto.com/exchange/document/margin-rules for a detailed explanation of how SCM works on the Crypto.com Exchange.
When Is a Smart Cross Margin Used?
Traders with multiple positions on margin and cross margin may find smart cross margin to be useful in volatile markets. This is because the mechanism may help users to avoid unnecessary forced liquidations and the resulting realisation of losses.
Moreover, smart cross margin, with its ability to offset margin requirements across positions in opposite directions and different product types, tends to be used by traders with complex portfolios. These portfolios could be holding long and short positions across spot and futures markets (e.g., for hedging). A trader might have a short futures position to hedge a long position in spot, but if the futures position gets liquidated due to margin deficiency, then the hedge would be gone. A smart cross margin could therefore be useful in this situation, as it offers the potential of avoiding forced liquidation where the various positions are balanced out.
Conclusion – Should You Opt for Cross Margins?
Cross margin allows for the sharing of margin balances across multiple positions, while an isolated margin is assigned to a single position, which cannot be shared. A smart cross margin allows for margin requirement offsets for positions in opposite directions and across different product types. The main potential advantages of smart cross margin are reduced chances of forced liquidation, lower margin requirements, and improved capital efficiency.
Due Diligence and Do Your Own Research
All examples listed in this article are for informational purposes only. You should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained herein shall constitute a solicitation, recommendation, endorsement, or offer by Crypto.com to invest, buy, or sell any coins, tokens, or other crypto assets. Returns on the buying and selling of crypto assets may be subject to tax, including capital gains tax, in your jurisdiction. Any descriptions of Crypto.com products or features are merely for illustrative purposes and do not constitute an endorsement, invitation, or solicitation. In addition, the Crypto.com Exchange and the products described herein are distinct from the Crypto.com Main App, and the availability of products and services on the Crypto.com Exchange is subject to jurisdictional limits. Before accessing the Crypto.com Exchange, please refer to the following links and ensure that you are not in any geo-restricted jurisdictions for Spot Trading and Margin Trading.
Past performance is not a guarantee or predictor of future performance. The value of crypto assets can increase or decrease, and you could lose all or a substantial amount of your purchase price. When assessing a crypto asset, it’s essential for you to do your research and due diligence to make the best possible judgement, as any purchases shall be your sole responsibility.
