14. Stablecoin vs Coin Margined

Introduction 

Cryptocurrency derivatives like futures, options, and swaps require traders to post margin as collateral to open and maintain positions. A central decision is whether to post margin in the underlying cryptocurrency being traded or use stablecoins like USDT or USDC. The margin mechanism impacts volatility, liquidation risks, and more.

Coin-Margined Contracts

Contracts that are coin-margined require traders to post margin in the actual cryptocurrency being traded. For example, trading a Bitcoin futures contract requires posting Bitcoin as initial margin. The main advantage of coin-based margining is full alignment between the value of posted margin and the notional value of the derivatives contract. 

As the price of the underlying cryptocurrency fluctuates, the balance of coins in your margin account moves in sync. This creates a direct relationship between margin and contract value. However, this also leads to the primary risk that margin levels can be extremely volatile. In fast moving cryptocurrency markets, frequently seeing 50-60% swings in the value of your margin balance is not uncommon.

This extreme volatility requires very close monitoring of margin ratios to avoid liquidation. Even with an initial margin cushion, adverse price swings can quickly eat into margin collateral and trigger liquidations. This is particularly risky with high leverage.

Stablecoin-Margined Contracts 

In contrast to coin-margining, stablecoin-margined cryptocurrency contracts isolate margin requirements from underlying volatility. Traders post initial and maintenance margin in stablecoins like USDT, USDC, BUSD, and others. These stablecoins maintain a peg to $1 USD, creating a flat margin balance.

The largest benefit this provides is stability in the margin account. Margin ratios are much easier to monitor and forecast when collateral value does not fluctuate. For many traders, this stability outweighs the costs and risks of volatile coin-based margining.

However, stablecoin margining also comes with trade-offs. The lack of direct linkage to the underlying cryptocurrency means divergence between the value of margin and the contract's value based on cryptocurrency price. This divergence grows as the cryptocurrency's price trends higher or lower. 

Traders also incur currency conversion costs when transferring margin funds from regular currency into stablecoins. This can create friction and fees for funding margin accounts.

Margin Maintenance Approaches 

Regardless of margin type, prudent traders actively maintain collateral levels. As unrealized losses accumulate on a derivatives position, margin ratios decrease. Falling below maintenance margin levels triggers liquidation of positions.

Common strategies to counter declining margin ratios include lowering position size or adding additional margin funds. However, this requires vigilance, particularly with coin-based margin volatility. Stop losses can also prevent losses from spiraling out of control.

Leverage Differences

The maximum leverage offered varies across cryptocurrency exchanges and specific contracts. While higher leverage requires less initial margin, it exponentially increases liquidation risks from volatility. Even at 100x leverage, a mere 1% price move against a position can trigger liquidation.

Risk management best practices suggest keeping leverage well below maximums, especially for coin-margined positions. Cryptocurrencies frequently see daily swings of 5% or more, meaning liquidations can happen suddenly even at 20-50x leverage levels.

Conclusion

In summary, coin-margined contracts provide exposure aligned with the cryptocurrency's movements but require exceptional risk management. Stablecoin-margin isolates collateral from volatility while introducing divergence. Consider personal risk preferences when selecting margin type and manage leverage proactively.