Margin trading, the “karaoke mic” of price discovery
The largest demand from altcoin traders has always been the same: more liquidity. At the end of the day, financial markets are buyers and sellers coming together with different price views and timelines, each one playing an influential role in the price discovery process. Liquidity — a byproduct of price discovery — is determined by the number of buyers and sellers over a given period.
Unfortunately, most altcoin markets resemble a failed bar. Imagine an empty bar (I know they’re all empty right now, but bear with me) on a popular street. Visitors have seen influencer ads that piqued their interest, so they walk by and see an empty bar with no vibe (liquidity). Without a convincing clientele to entice them inside, they go to the bar next door where there are people — hundreds of them, every night. Why?
The short answer is that the first bar has a “lack of liquidity” (or “vibe”). The longer answer is this:
Spot-only markets limit price discovery
Not everything can be (or should be) liquid; however, spot-only markets and fragmented ownership heavily hinder the potential for liquidity. Due to the nature of spot markets, sellers need to hold the assets they wish to sell. In many altcoins’ case, these holders are often investors with a long-term view that ignores short-term price movements. This creates a disconnect of time horizons between the buyers and sellers, effectively not allowing the market to function and preventing price discovery from taking place. This then translates into nonexistent liquidity.
Oversimplified and exaggerated example:
Funds and whales invest in a project, take most of the supply, and continue to accumulate any potential circulating supply along the way with a very “bullish” view of the project. However, the price is not moving. The reason is a catch-22: there are no sellers because the price is not high enough, but the price isn’t high enough due to the fact that there are not enough sellers. It’s a dead end.
Margin trading is the “karaoke mic”
Margin trading allows traders to borrow funds for the purpose of trading and take a leveraged long or short position. Simultaneously, margin lending allows long-term holders to lend their funds to traders, earning extra interest that would otherwise be unavailable. For example, a trader who expects a price drop due to a recent mainnet launch delay can open a short position. Essentially, margin trading bridges the timeline disconnect and allows the long-term holders’ assets to be put to use by more short-term traders, generating liquidity and interest income along the way. Similar insights can be found when looking at empirical studies done on emerging market stocks. Rather than a dead end, we’ve reached a win-win.
Suddenly, in our imaginary bar, some people have come in to sing karaoke. This, in turn, has caused new customers to come in for a drink, as suddenly a “vibe” is starting to form…
The same mic can also be used to “boo” bad actors
An added benefit from holders’ assets being put to use is the protection from market manipulation. Normally, market participants that see a “pump and dump” are unable to act on it, as they don’t hold the underlying token. However, margin trading allows anyone to open a short position and use selling pressure to slow down manipulation and prevent capital destruction. In our imaginary bar, disorderly and abusive actors can now be booed off the stage by other bar visitors.
Exercise caution
Just like too much loud karaoke, reckless margin trading can also ruin the party. Cascading liquidations are incredibly destructive for all parties and are a sign of over-leveraged markets. It’s the duty of the exchange to set reasonable limits for traders in order to prevent the market from becoming over-leveraged.
Why are we talking about this in weird analogies?
Because this is precisely the thesis that our exchange — Multi.io — is built on. We allow traders to leverage exciting long and short tokens, as well as the token-holders, to earn interest on their funds, effectively creating a healthier market along the way. Learn more about us here. (link to medium post)
TLDR: Spot markets are fragmented, and potential liquidity is suppressed by holders’ capital being under-utilised. Margin trading allows them to earn interest, while borrowers trade with it and gradually improve liquidity. In addition, short selling makes it considerably harder to manipulate markets.
