What are Isolated Margin and Cross Margin in Crypto Trading?

Introduction

To successfully trade cryptocurrencies with minimal risks, individuals need to consider various factors and follow certain steps. It is crucial to have in-depth knowledge about trading, market trends, exchanges, wallet security, and other necessary concepts that aid in trading cryptocurrencies. It is also essential to have an adequate understanding of the right trading strategies and risk management measures that can shield you from falling victim to the rapidly volatile crypto market.

Trading cryptocurrency is usually the first point of entry for newcomers coming into the crypto space. Crypto trading refers to the economical concept of buying and selling digital assets and can be in the form of swing trading, day trading, arbitrage, scalping, or buy and hold. Crypto exchanges have improved the attractiveness of crypto trading by introducing margin trading, allowing users to stake higher amounts of assets than they can afford.

Margin trading is one of the ways traders can bet on an asset’s future price to improve their earning potential. To ensure flexibility according to the preference of each user, margin trading can be in the form of isolated and cross-margin. This article highlights everything you need to know about isolated margin and cross margin and how to navigate the risks, uncertainties, and complexities involved.

What is Margin Trading?

Source: Cryptostars.is

To grasp the technicalities involved in isolated margin and cross margin in crypto trading, there is a need to understand the underlying concept; margin trading. Essentially, in margin trading, the trader borrows funds from the cryptocurrency exchange to carry out a trade they cannot afford, that is, the trader has higher buying power and can open larger positions to earn more. Let’s explore a few terms that are commonly used in margin trading for easier comprehension:

Leverage

Leverage simply refers to the use of borrowed funds to trade. The crypto exchange or broker borrows traders extra funds so they can make transactions higher than what they can afford. This enables them to make larger bets in hopes of earning bigger profits.

For instance, a trader has $2,000 and thinks the price of Cardano (ADA) will increase. They can either buy ADA directly with the $2,000 or leverage a position to trade on borrowed funds. If the trader buys $2,000 worth of ADA and the price increases by 20%, the investment will be worth $2,400 (the $2,000 capital and $400 profit).

The trader may harness leveraging to further improve their stake. Using 5x leverage, for example, the trader will borrow four times their initial capital and boast of higher funds to invest with. In our example, the trader will borrow $8,000 from the exchange, making a total of $10,000 in investment funds. With a 20% increase in ADA price, the $10,000 investment will be worth $12,000. The trader pays back the borrowed $8,000 and is left with $4000. That is a 100% return on their initial investment.

However, crypto trading is not always as beneficial as earlier outlined. Imagine an opposite scenario where the price of ADA dropped by 20%. The investment without leverage will suffer a 20% loss, leaving the trader with $1,600. But with the 5x leveraged position, the trader suffers a 20% loss on the $10,000, leaving them with $8,000. The exchange platform takes the borrowed $8,000 leaving the trader with nothing (100% loss). Note that the examples presented throughout this article show a simplified scenario and don’t take trading fees, loaning interests, and other factors into consideration.

Margin

Another term to explore is margin. Initial and maintenance margins are two margin requirements in margin trading. Initial margin refers to the amount of collateral the trader must commit to open trade while maintenance margin is the minimum amount needed to keep that position from getting liquidated. If the asset fluctuates and goes below the maintenance margin, the trader gets a margin call which signifies that they will lose the position and they need to put more funds into the account to keep the position open.

Source: dYdX Academy YouTube Channel

Liquidation

If the trader fails to meet the margin call, the crypto exchange may be forced to sell the asset in the account to offset the borrowed funds the trader used to leverage. This act of losing all the initial margin is called liquidation.

What is an Isolated Margin?

To facilitate the margin trading process, many crypto trading platforms use different types of margin types, with the isolated margin and cross margin being the most common ones. Let’s begin by understanding what isolated margin is and how it works.

In an isolated margin, the trader decides the amount of funds they want to allocate for a position, meaning that if liquidation happens, it only affects the allocated funds and not the total funds in the trader’s account. This also means that other positions in the trader’s portfolio are not affected by the market dynamics happening in the isolated margin wallet.

To further elaborate, the initial margin in the isolated margin mode is independent of and unaffected by other trading pairs. Traders can only transfer, borrow, and hold the specified crypto in each isolated margin account and if liquidation happens, it won’t affect other isolated margin portfolios. This means the trader can control the outcome of a specific portfolio and this strategy is highly effective in speculative positions.

Imagine a trader has 5 Bitcoin (BTC) and wants to allocate 2 BTC for an isolated margin trade with 5x leverage. They transfer the 2 BTC into the BTC/ETH isolated margin account to open a leveraged Long position on Ethereum (ETH), betting that its price will go up. With the 5x leverage, the trader borrows 8 BTC from the exchange, allowing for a trade with a total of 10 BTC. If the price of ETH goes up and the trader closes the position, the trader gains a profit. However, if the price of ETH drops drastically, the maximum the trader can lose is 2 BTC. Even if the position gets liquidated, only the 2 BTC is affected and the remaining 3 BTC in the trader’s wallet is left untouched. This is why this mechanism is called “isolated.”

How to Trade with Isolated Margin on Gate.io

Step 1: Log in to your Gate.io account. At the top menu, hover on “Trade” and click on “Margin.”

Step 2: Select the trading pair on the left panel. We’ll use the GT/USDT pair in this example. Click on “Isolated Margin.”

Step 3: Click on “Transfer” to send the desired fund from your spot trading account to your isolated margin account. Select the coin pair, enter the size of the transaction, and then confirm.

Step 4: To set the leverage, check the “auto-borrow” option when placing your order so that the system auto-borrows for you.

Step 5: Alternatively, you can borrow funds manually. Click on “Borrow” in the assets section to manually borrow.

Step 6: If you wish to Long the asset pair, click on “Buy.” If you wish to Short the asset pair, click on “Sell.”

Step 7: Check all the information on the display screen. If everything is accurate, click on “Confirm Order.”

Step 8: After successfully placing your order, you can view it in the “Open Orders” section. Also, you can cancel your order anytime by clicking “Cancel.”

What is Cross Margin?

Cross margin is the most common form of margin trading and it is usually the default mode on most trading platforms. Also known as spread margin, this mode uses the entire amount in the available funds as collateral for trades. This means that when a position moves against a trader and another moves in their favor, the profit from the beneficial trade can be used to cover the loss, keeping the trader’s position open for longer periods.

Unlike isolated margin which allows a trader to open multiple isolated margin accounts, a trader can only open one cross-margin account on their crypto trading account. The margin level is calculated based on the total assets and total debt in the cross-margin account. At extreme market conditions, the trading platform sends margin calls to the trader signifying potential liquidation or the need for closing a position or adding more funds to keep the positions open.

Let’s explore how cross-margin works. For example, a trader has 10 BTC and decides to open a leveraged Long position on ETH and another leveraged Short position on ADA. For ETH, the trader allocates 4 BTC and the remaining 6 BTC to ADA, both at 2x leverage.

Imagine that the price of ETH drops leading to a loss on the Long position, and the price of ADA drops too leading to a profit on the Short position, the profit from ADA can cover for the loss from ETH, keeping both positions open. However, if the price of ETH drops significantly and the price of ADA increases, this is a loss on both positions and if this loss exceeds the maintenance margin, both positions can be liquidated and the trader loses the total 10 BTC balance offered as collateral. This is very different from isolated margin trading where only the allocated amount is affected.

How to Trade with Cross Margin on Gate.io

Step 1: Log in to your Gate.io account. At the top menu, hover on “Trade” and click on “Margin Trading.”

Step 2: Select the trading pair on the left panel. We’ll use the BTC/USDT pair in this example. Click on “Cross Margin” below the chart.

Step 3: Click on “Transfer” to send funds to your cross-margin account. Select the coin, enter the volume of the transaction, and then click “Transfer Now.”

Step 4: Click on “Borrow” to obtain funds for leverage trade. Select the asset you want to borrow, enter the amount, and click on “Confirm Loan.”

Step 5: Set the buy/sell price and buy/sell amount. If you wish to Long the asset pair, click on “Buy.” If you wish to Short the asset pair, click on “Sell.”

Step 6: Check the imputed values for price and quantity. If accurate, click on “Confirm Order.”

Step 7: After successfully placing your order, you can view it in the “Open Orders” section. You can cancel your order anytime by clicking “Cancel.”

Differences between Isolated Margin and Cross Margin

From the foregoing, it is obvious that while both are examples of margin trading, the isolated margin is a secluded trading mode while cross margin uses the profit and loss (PNL) from other positions to keep the trading open. Here are the differences based on the following contexts:

Risk management

While isolated margin trading allows for more granular risk management, cross-margin combines risks across all portfolios. In essence, a trader can control the amount of funds they are risking under the isolated margin mode. While cross-margin can be beneficial when managing multiple positions to ensure that they remain open for longer periods, the combined risks may also potentially indicate higher losses or gains.

Managing Risks

Isolated trading is more suited for traders who want to manage risks on a single-case basis, especially when they have high expectations from them and want to keep the risks separate. Cross margin, on the other hand, is more suited for traders who prefer multiple positions that are hedging against each other.

Flexibility

Cross margin offers the trader the ability to allocate funds automatically since all available funds in the wallet will be used for trading. However, funds allocation in isolated margins is manual, forcing a hands-on approach in terms of margin maintenance.

Collateral and liquidation mechanisms

In isolated trading, the liquidation potential depends on the amount allocated by the trader. In essence, if the trader sets aside 2 ADA in his isolated margin wallet, only those 2 ADA are at risk of liquidation. But in cross-margin, all available funds in the wallet are used as collateral for the collective trading and all are at risk of liquidation.

Isolated Margin Vs. Cross Margin: Pros and Cons

Source: Techreport.com

Isolated Margin

The advantages and disadvantages of isolated margin trading are discussed below.

Cross Margin

The following are the advantages and disadvantages of cross-margin trading.

Choosing between Isolated Margin and Cross Margin

It is pertinent to note that there is no right or wrong regarding cross-margin and isolated-margin trading. The risk management strategy of the trader will determine which margin mode is best suited for them.

If proper risk management strategies are put in place, liquidation can be avoided in both margin trading modes. For traders who prefer a speculative position where initial margin loss should be limited, an isolated margin mode is the best fit. Also, an isolated margin is best for traders who open a highly leveraged position, and a higher degree of control is preferred.

On the other hand, cross-margin will be more attractive for traders who prefer hedging positions and those who want to benefit from leveraging long and short positions simultaneously. Because of the unique use case of both margin trading types, some traders concurrently use both modes to effectively manage trading risks and accrue more gains. The question of which is better, therefore, is a matter of preference, rather than superiority.

Conclusion

Margin trading, through isolated margin and cross margin, offers traders the opportunity to gain higher profits. However, there is also a risk of losses and liquidation in these marketing modes. The choice boils down to the trader’s preference, trading strategy, risk tolerance, and level of active involvement in the trade.

To be successful in crypto trading, traders have to understand the dynamics involved in each trading mode to make informed decisions. A well-informed trader who understands the intricacies of both margin types will be better equipped to navigate the volatile world of cryptocurrency.