How To Build A Diversified Cryptocurrency Portfolio Through Leverage
- Crypto Margin Trading Basics
- Is Margin Right For You?
- Take A Look At CFDs As An Option To Leverage Cryptocurrency
- Own One (Or More) Cryptos Outright While Staying Diversified In Stocks
- Conclusion: Respect The Risks
Savvy and sophisticated traders and investors have been taking advantage of leverage to trade stocks or gold for quite some time. Buying and selling cryptocurrency on margin is no different than any other asset class and brokers have been scrambling in recent years to address the surge in popularity for digital currency exposure.
Proper and responsible use of cryptocurrency margin trading to maximize profits lets investors build a more diversified portfolio that is able to withstand near-term volatility.
Crypto Margin Trading Basics
Trading or investing cryptocurrency on margin is a term that is often interchanged with leverage. In essence, a cryptocurrency broker extends financing to clients to amplify their ability to trade or invest in one or more cryptocurrencies.
Brokers typically extend leverage based on a multiplier on the cash balance. A margin rate of 50 times on a deposit of $5,000 means an individual has access to $250,000 worth of buying power.
Of course, the broker charges interest and fees on the borrowed capital because access to someone else’s money is never free. Individuals are for the most part free to trade or invest in cryptocurrencies how they see fit but specific rules and guidelines vary by broker.
Some brokers may offer exclusive rates or other perks to high net worth individuals or sophisticated investors with a proven track record.
Is Margin Right For You?
Building a portfolio of digital coins via margin is not for everyone. Given the already volatile nature of cryptocurrencies, it is particularly easy for new and beginning investors to get caught on the wrong side of a trade and lose a lot of money very quickly.
If the size of the trade is magnified with borrowed money from a broker, the investor risks losing money above and beyond their initial deposit. But margin can be a great tool for investors that fully understand the importance of diversification, when to bank a profit, and how to quickly exit a losing position.
Take A Look At CFDs As An Option To Leverage Cryptocurrency
CFDs, or contracts for difference, represent a unique way for cryptocurrency investors or traders to take advantage of a unique form of leverage. A CFD is essentially an agreement in which an individual speculates on the direction of an asset, in this case, bitcoin or any of the other major cryptocurrencies.
The investor does not own the asset outright, rather they generate a profit if the cryptocurrency gains in value (for a long position) or loses in value (for a short position). Some brokers even give investors exposure to crypto/crypto CFDs, such as BTC/ETH.
The true beauty of CFDs is the holder of a contract will still receive 100% of the gains (fewer fees) if the price moves in the right direction.
What makes CFDs particularly attractive to margin traders is the cost to enter the contract is a percentage of the trade’s overall value. An investor looking to build a portfolio of cryptocurrencies with a $5,000 deposit can enter 10 different CFDs on 10 different cryptocurrencies if the broker requires a 10% deposit.
Instead of investing the $5,000 in one or two cryptocurrencies and acquiring a small position that is overexposed to volatility, an investor can acquire a portfolio of the following cryptocurrency pairs:
Own One (Or More) Cryptos Outright While Staying Diversified In Stocks
The largest drawback of CFDs is it does not give the holder ownership of an underlying asset. While this option might be more suited for day traders or swing traders, investors can still build a portfolio through the regular leverage a broker offers.
Suppose an investor with a stock portfolio valued at $500,000 wants to add exposure to bitcoin. The investor is assuming their stock portfolio can return 15% annually so a 10% exposure to bitcoin is a reasonable position. Even under an absolute worst-case scenario where bitcoin collapses 80% in a year, the investor’s diversification to stocks means they can still end the year richer.
The problem for the stock investor is all of their holdings are running hot and deciding what stocks to sell to raise $50,000 is a difficult task.
But thanks to the ability of trading cryptocurrencies on margin, this problem has become a lot easier. A broker that offers ten times margin means the same $50,000 investment in bitcoin requires just $5,000.
If the $45,000 remains exposed to large dividend-yielding stocks, the quarterly payouts would be more than enough to offset the fees associated with cryptocurrency leverage.
The same concept holds true if the investor wants to allocate the same $50,000 (or more) towards cryptocurrencies and build a portfolio of five or six coins.
Conclusion: Respect The Risks
Trading cryptocurrencies on margin comes with risk potential that other investors don’t have to worry about. An investor that trades with no margin will never have to worry about losing more than 100% of their deposit or dealing with embarrassing and awkward margin calls.
As is always the case across all asset classes, leverage and margin buying should be reserved to responsible and savvy investors only. Many brokers are quick to hand out leverage to anyone and everyone and it is not their responsibility to ensure each client knows what they are doing.