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Understanding Margin Call in Crypto

by Uneeb Khan

The term margin call refers to a request by your broker for you to bring in some additional money, or collateral, so that you can make good on your promise to pay off your debt. Basically, if you’ve borrowed money from the broker to buy stocks or other digital assets and trading pairs like BTC ETH or DOGE/USDT and the value of those assets drops below a certain point, the broker will ask for additional money to make up for the difference.

What is A Margin Call?

A margin call is an event that occurs when your losses on an asset you’re holding have reached a point where your lender has decided to call in the rest of the money that you owe.

A margin call is a request to put more money into your account so that you can meet the minimum balance required to keep it open. If you do not meet the margin call, then your account will be liquidated—the money in it will be used to pay off the debts and close out your position.

What Are Margin Calls For?

Margin calls are a way for exchanges to protect themselves from investors who might be overextending themselves financially. If a trader’s value of their account goes below the margin requirement, the exchange will issue a margin call and ask them to put more money in the account so that it doesn’t get liquidated. 

When you look at an exchange’s terms of service, you’ll notice that the vast majority of exchanges have similar rules: if your crypto holdings go below 30%, 50%, or even 100% of your margin requirement, they will force you to deposit more funds or they’ll close out your position.

Margin calls are the last line of defense for a crypto exchange. Exchanges don’t want to be the ones to cut off their customers’ access to funds, so they provide a way for you to cover the difference when the price of your positions drop. 

The exchanges wouldn’t allow you to go into a negative balance—it’s impossible for them because they’ll lose money if they allow that to happen—so they make sure they have enough collateral before allowing you to open new positions or add additional funds so that you don’t gamble away their money along with yours.

Ways To Avoid a Margin Call

There are two ways to avoid this happening: either never use leverage at all or make sure that you can afford to lose your entire investment if prices fall too low. It is common sense advice, but many investors fail to follow it because they believe they can make a lot of money by buying assets at prices that they believe will go up in value. However, they don’t take into account their own emotions and errors in judgment, which lead them into making bad decisions when things go wrong.

Another basic way to avoid a margin call is to never trade with more money than you have. Make sure that you’re keeping track of how much money you have available at all times, so that you can keep an eye on how close your total exposure is getting to your capital. 

If it seems like something could happen that would put you at risk for a margin call, make sure to close out of any positions before it gets too late. It’s better to lose a few dollars than it is to wipe out your entire account.

What You Should Do If You Receive A Margin Call

Just like any other investment, it’s possible for the value of your holdings to fall below the amount you borrowed to purchase them. When this happens in crypto, it means you have a ‘margin call’, which is an official request from your exchange that you immediately deposit more funds to cover your losses.

In most cases, margin calls are issued by exchanges when the price of Bitcoin, ETH, XLM or other assets has fallen. The price fall may be due to a drop in demand, or as a result of an increased supply (for example, more tokens being added to an ICO). 

Let’s say, if the XLM price continues to drop below the amount of your loan, there is no way for you to make up the difference, so this is why exchanges issue margin calls: they want to make sure their users don’t lose more than they can afford.

If you don’t take action and deposit additional funds within a specified timeframe (which varies per exchange), your account will automatically be sold off and the proceeds used to pay off your debt. This means that you will lose everything else that was not being used as collateral for the loan.

Final Thoughts

This might sound like a scary thing, but it goes without saying that it’s far better than losing all of your investment or getting stuck with a debt you can’t pay off. A good broker will also try to protect investors by putting limits on how much they can invest in risky assets like cryptocurrency. 

Brokers that don’t have a lot of experience with cryptocurrency may not understand the risk involved with speculating on coins, and may seem pushy about investing more than you want to. That’s why it’s important to either do research on your own before picking a broker and setting up an account, or finding one with experience in crypto who is willing to take a conservative approach in helping you invest.

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