Today, we are tackling differences between decentralized app vs its centralized application counterpart. We're looking at:
Trading: Spot VS Margin
If you heard about the recent farce about the meme stock: Gamestop. You might have heard of the term short squeeze and subsequently: Shorting. The term short can be connected to margin trading. Let me explain further:
Margin trading simply means borrowing capital from another person/institution and using that capital (sometimes together with your own capital) to trade in the market. Short selling means that you use margin trading to gain profits by predicting that prices will go down. For shorting you borrow stocks at a margin, sell them, then get profits by buying low. The opposite can also be applied where you borrow stocks at a margin, keep them, then sell them for profit when prices go up.
What exactly is margin trading? And how does it differ with spot trading?
Spot trading is very simple. You have money, you buy a certain cryptocurrency and then you sell it afterwards.
For margin, as mentioned before, you borrow existing stocks/cryptocurrency, then you trade as you see fit. Margin is the term used for the interest you pay.
In the cryptospace, exchanges will let you borrow capital to use for trading, you must have initial; deposits which will be the gauge of how much capital you can borrow. Oftentimes they are used as collateral by the exchange as well. This initial deposit is what we call the initial margin. The amount will depend on the rules designated by the platform itself. Then you can trade for short or long positions afterwards.
The Pros and Cons:
There's a main advantage and main disadvantage of using margin trading when doing cryptocurrency trading.
The biggest advantage is that you can exponentially gain profits depending on how much leverage you have and how you play your short or long positions. This helps a lot by letting you borrow capital that you don't actually have, making profits higher than usual.
The biggest disadvantage though, is if you don't play your cards right and your trade isn't that successful. This would mean that you may lose more than what you have. Since you're not trading your own money, and sometimes, that money is even bigger than your initial margin. Worse comes to worst, you did margin for a short position and you got squeezed out of it, that loss may become astronomical.
For spot trading it's also simple, pro is you have minimal risk, but con is you can't have more profit than usual.
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