With a tug-of-war going on between crypto and regulations, margin trading in the US is quite difficult. Here is a guide to simplify the process for the US citizens!
The much-anticipated tug-of-war between “cryptocurrencies” and “regulations” is truly up and running. From blanket bans to extreme taxes on profits to Bitcoin being legal tender, crypto regulations is one of the hottest topics currently. All this while countries and governments across the globe are trying their best to tame this wild beast.
Another fact is that when governments get involved, people take notice. So, even in this rough water, the net positive is that more people are getting to know about and trying to understand crypto. This may essentially translate into more people joining the crypto bandwagon to have their skin in the game.
However, while most regulations are policy whips being cracked to keep the citizens under control, there are certain rules that can have an ulterior positive attached to them. One of them is the rules around ‘margin trading’ and especially in the USA. Now, read along to know what margin trading is, the associated regulations, and more about them.
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What Is Margin Trading?
Simply put, it is a financial method of engaging in trading activities using money borrowed from a third party, for which, your existing investments act as collateral. In this, the brokerage firm or platform gives you upfront capital to trade in the market, and this capital is offered against your already-owned assets and securities.
Think of it as a loan that is specially offered for trading purposes. Also, margin trading, as a trading mechanism, has grown in popularity in recent years. Unlike banks or other lending institutions, you can borrow money for a comparatively lesser interest rate and with less paperwork and negotiations.
Most importantly, think of margin trading as a catalyst for your trading performance. If your bet wins, you can book extraordinary profits. If not, you need to repay more than your initial borrowed capital. Also, interest is charged which only amplifies the losses incurred by the trader.
Now having understood how margin trading works, let’s dive deep into the prominent risks a margin trader needs to account for.
On a side note, you may check out our guide on spot trading vs margin trading!
Risks Associated With Margin Trading
Losses Are Magnified
As stated earlier, traders going wrong on margin trading calls can end up losing substantially more than they had initially invested. Unlike the spot market where traders can only lose their cash in hand, margin trading ensures the trader is indebted to the broker.
The Dreaded Margin Calls
For every dollar borrowed on margin debt, a percentage of equity i.e. spot holdings is locked as collateral. When the value of this equity falls below a certain value, a margin call is triggered by the broker. This is a call for the trader to add funds or liquidate equity to meet the collateral value. If the trader doesn’t tend to the call, the broker can sell the holdings to recoup the cash.
Liquidation of Collateral
Drawing reference from the previous point, the collateral locked against the margin loan can be liquidated by the broker if the margin call isn’t met. Adding to that, the remaining part of the loan is viewed as an unsecured debt. This is further reported to credit rating agencies where the trader’s credit score takes a hit.
Studying these risks attached to margin trading, regulatory authorities in the USA i.e. CFTC - Commodity Futures Trading Commission and NFA - National Futures Association have cut short exchanges from offering margin trading facilities.
Let us now delve more into the regulations in place with regard to margin trading.
Regulations Around Margin Trading for US Citizens
Simply put, the US and its regulators have decided to not provide licensing to any cryptocurrency exchanges that provide margin trading to users. Though crypto derivatives, as an investment avenue, are growing across the globe, US citizens have negligible means to leverage margin trading.
According to US Code: Title 7, only FCMs or Futures Commission Merchants - registered with the Commodity Futures Trading Commission are allowed to offer cryptocurrency derivatives and trading services.
Regardless, Coinbase Pro, a wing of popular crypto broker Coinbase, was offering margin trading services. But, in late 2020, they were instructed by CFTC and their guidelines to immediately discontinue the margin trading product. Coinbase mentioned that they are working with regulators to achieve ‘clear, common-sense regulations……to protect and provide peace of mind to US customers.’
The crypto market in 2021 was not a bed of roses to any extent. And more so for BitMEX, a P2P platform for crypto products which was ordered to cough up a fine of $100 Million by the Federal Court of the US. The reason for this fine is BitMEX offering derivatives and/or margin trading services to US citizens which violates the Commodity Exchange Act (CEA).
Apart from these instances, the CFTC has imposed sanctions on 14 such crypto participants for offering derivatives and margin trading services. One of the key observations of these sanctions is that the CFTC maintains that the $1.25 Million sanctions on Kraken were “a part of the CFTC’s broader effort to protect U.S. customers”.
To add to the anguish, McDermott Will & Emery (MWE), a reputed law firm, expects more regulations in the crypto space. Apart from the CFTC and SEC, MWE also expects the Treasury and Office of the Comptroller of the Currency to wield influence over the nascent industry of crypto. Barring this, individual states also have their own laws regarding financial services.
While the recent past has been a nemesis for the margin trading sect of the crypto market, do we have a way out? Let us find out.
How to Margin Trade in the USA?
There is only one authorized and trustworthy platform to margin trade in the US i.e. Kraken, a US-based cryptocurrency exchange and bank.
Users within the US must be having either intermediate or pro tier verification intact. Alongside, there is a financial limit to be met for the conduct of margin trading on Kraken.
Individual clients must have more than $10 Million in invested assets (crypto, stocks, bonds, mutual funds, real estate).
For institutional clients, the represented institution must qualify as an ECP (Eligible Contract Participant) under US law. Then, they must have more than $10 Million in total assets.
Additional tip: Users outside the US must verify to the intermediate tier to continue margin trading. Those with pro-tier verification will not be affected.
Kraken offers margin trading on more than 35 cryptocurrencies including bluechip cryptos like Bitcoin, Ethereum, Litecoin, and others. For the complete list, read here.
All of them can be traded in pairs either with $BTC, $USD, $EUR, or $ETH.
This is where the potential of margin trading is effectively capped for US citizens. Kraken only allows 5x leverage for US citizens. To add context, non-US users enjoy Futures with up to 50x leverage.
The 1:5 leverage cap of Kraken is to substantially comply with the regulators and provide safe, yet, profitable margin trading opportunities to US citizens.
Fees on margin trading on Kraken are extremely competitive and they seem reasonable for the majority of the crypto population.
Fees up to 0.02% shall be charged to open a margin position and for every four hours of maintaining the ‘open’ position, a rollover fee of max 0.02% will be charged.
There is no denying the advantages offered by margin trading for users to leverage in the crypto market. However, they should never overshadow the innate potential of losses that can mount in quick time due to wrong bets. To protect traders against such calamities, regulators in the US have proceeded with a concrete wall around margin trading.
US citizens, even those living outside the US, shall have to forego the upside attached to margin trading. And with a negligible indication of this situation changing, margin trading will remain alien to the US for some more time. Until then, meeting the requirements of Kraken and playing with 5x leverage seems to be the best bet.
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I am an expert in cryptocurrency and financial markets, with a deep understanding of the intricate relationship between cryptocurrencies and regulatory frameworks. My expertise is demonstrated by an in-depth knowledge of the crypto landscape, regulatory developments, and the nuances of margin trading in the United States.
The article highlights the ongoing struggle between cryptocurrencies and regulatory measures, particularly focusing on the challenges of margin trading in the U.S. Let's break down the key concepts discussed in the article:
1. Cryptocurrency Regulations:
- The article emphasizes the global tug-of-war between cryptocurrencies and regulations.
- Various regulatory measures are mentioned, including blanket bans, extreme taxes on profits, and the recognition of Bitcoin as legal tender in some cases.
- Governments worldwide are actively trying to regulate the cryptocurrency space.
2. Margin Trading Defined:
- Margin trading is explained as a financial method involving trading with borrowed money where existing investments act as collateral.
- Brokers provide upfront capital for trading against the trader's owned assets and securities.
- It is likened to a loan for trading purposes, with the potential for extraordinary profits or amplified losses.
3. Risks Associated with Margin Trading:
- The risks of magnified losses, margin calls, and the liquidation of collateral are discussed.
- Margin calls are triggered when the value of equity falls below a certain level, and traders must add funds or liquidate equity to meet collateral requirements.
- The article emphasizes the negative impact on credit scores if collateral is liquidated.
4. Regulations in the U.S.:
- U.S. regulatory bodies, specifically the CFTC (Commodity Futures Trading Commission) and NFA (National Futures Association), restrict exchanges from offering margin trading facilities.
- The article mentions specific regulations outlined in the US Code: Title 7, allowing only registered FCMs to offer cryptocurrency derivatives and trading services.
- Instances of enforcement actions against exchanges violating regulations, such as Coinbase Pro and BitMEX, are highlighted.
5. Authorized Platform for Margin Trading in the U.S.:
- Kraken is presented as the sole authorized platform for margin trading in the U.S.
- Eligibility criteria for users, financial limits, and product offerings on Kraken are detailed.
- The article underscores the limited leverage (5x) allowed for U.S. citizens on Kraken, in compliance with regulators.
6. Fees and Final Thoughts:
- Competitive fees on Kraken for margin trading are mentioned, with details on opening positions and rollover fees.
- The article concludes by acknowledging the advantages and potential losses of margin trading, emphasizing the stringent regulatory environment in the U.S.
In summary, the article provides a comprehensive guide to margin trading in the U.S., covering regulations, risks, and the specific platform available for U.S. citizens.