DeFi protocols have solved the scarcity of digital assets in the crypto landscape by allowing traders to borrow and trade with them at much lower interest rates and make profits. Specifically, on Nuo, traders can open both long and short positions on any of the available ERC-20 based token by staking other ERC-20 tokens as collateral.
Note: Short is when the traders indulge in trading, expecting the value of the crypto assets to go down, while long is when the traders indulge in trading, expecting their value to go up.
Margin trading, however, has its share of risks, along with profits.
Importance of collateral in Margin Trading
Margin trading is when traders borrow digital assets from lenders by using their holdings as collateral, and they use that loan for trading. A DeFi protocol such as Nuo Network, a 100 percent non-custodial lending platform, facilitates borrowing, lending, and margin trading of crypto assets.
On Nuo Network, crypto traders can instantly borrow ETH or ERC20 tokens from debt reserves by pledging collateral in the smart contract.
- Collateral: Crypto holders can use the crypto assets that they hold as collateral, instead of selling them or trading with them. This way they retain ownership over their assets while also getting the funds to trade. They can get back their assets after fully repaying the loan. The crypto market is notoriously volatile — the value of a crypto asset fluctuates every day. Hence, on most DeFi protocols, the collateral value exceeds the loan value. It makes sure that the lender does not suffer a loss in the case of loan default.
Margin Call: When Value of Collateral Decreases
A margin call happens when the value of the collateral falls below a certain amount, which increases the loan-to-value (LTV) of the borrowed assets. In such a scenario, the borrowers are asked to deposit additional crypto assets as collateral, so that the value of the loan does not surpass the value of the collateralized assets.
On Nuo Network, the traders can trade up to 3x leverage on their collateral. For example, they can trade for 3 ETH if they have put 1 ETH equivalent collateral. And, as the entire margin trade amount in the smart contract, it can be margin called when it touches stop loss. This ensures that the lender does not suffer a loss if the borrower does not post more collateral during the margin call period.
- Stop Loss: A stop loss is an automatic order that a trader places to sell or buy once the value of the crypto asset reaches a specific level. It protects both the lender and the borrower from excess loss. In Nuo Network, the stop loss is at the 80 percent mark. So, when the margin trade hits the stop loss mark, the platform will automatically trigger the margin call, and the losses are deducted from the remaining collateral. The rest of the amount is returned to the trader’s account balance.
How to Deal with Margin Call?
There are two ways by which traders can deal with the margin call on crypto loan:
- Add to the collateral that they posted to obtain the loan, therefore reducing LTV to at least 70 percent.
- Repay a part of the loan, and reduce the LTV to at least 70 percent.