Margin Call Misery

Dear Dr. Per Cap:

I bought some bitcoin last year using a margin account with an investing app. It was cool because I was able to buy more bitcoin than the money I had in my trading account. However, my bitcoin is now worth about half of what I paid for it and to make matters worse, the app is telling me I have to deposit more money in my account, or they’ll sell my bitcoin at a loss. Can they do that?

Signed,

Burned by Bitcoin


Dear Burned,

It might not seem fair, but that’s how it works in the fast-paced world of speculative margin trading.

Here’s what happened: A margin account is a way to trade securities using borrowed money. A loan so you could invest more money in bitcoin than you actually had in your account. No different really than an auto loan or a credit card.

Experienced investors use margin accounts all the time. Except instead of calling them debt, they use the dubious term, “leverage.” If all goes well, the investments they purchase on margin go up in value and they sell them for more than what they paid, including interest. Then they go look for another hot investment to buy on margin. Rinse and repeat.

Unfortunately, many bitcoin investors who bought in last year when the price was soaring haven’t done so well. As of mid-July 2022, the price of bitcoin is down more than 65% since its November 2021 high of $67,802.

If a margin account runs low on funds from a losing trade on bitcoin, stock, or any other margin security, it’s common practice for a brokerage, in this case an investing app, to make a margin call. A margin call is serious and requires the account holder to deposit either money or additional securities to bring the account up to a minimum balance.

This is called the “maintenance margin,” which the Financial Industry Regulatory Authority (FINRA) requires to be at least 25% of the total market value of the margin securities in the account. However, some brokerages might require a higher percentage. Bitcoin falls into a gray area when it comes to regulation, so pay attention when pledging it as collateral.  A brokerage can indeed demand a margin call and many individual investors have gotten hit with margin calls during the recent market downturn.

It’s totally fair; however, what’s sad is how aggressively some investing apps and crypto exchanges have been selling ordinary investors on the idea that bitcoin and other cryptocurrencies are the secret to fortune and glory. So much so that many inexperienced investors have purchased crypto with money they didn’t have.

Sorry you lost this round of the crypto war, but please don’t sour on investing. It’s still a great way to build wealth and protect your money against the damaging effects of inflation. You just have to be mindful of the risks, educate yourself on what you’re actually buying, and by all means be super careful investing with a margin account.

For more information on margin accounts, check out this timely investor bulletin from the Securities and Exchange Commission.

Ask Dr. Per Cap is a program funded by First Nations Development Institute with assistance from the FINRA Investor Education Foundation. For more information, visit www.firstnations.org. To send a question to Dr. Per Cap, email askdrpercap@firstnations.org.