Most traders do not understand how Bitcoin derivatives exchanges (BTC) deal with their risks. We agree that the losers get paid from the winners, but this is not as simple as it sounds.
Initially, insurance funds were designed to protect customer positions in unstable periods. However, some stock exchanges, such as BitMEX, show a relatively stable insurance fund, despite significant hourly fluctuations in the price of 10% or more.
The chart above shows that BitMEX Insurance Fund (orange line in terms of BTC) was unharmed after the liquidation of $ 1 billion on March 12.
Every time the position is closed due to insufficient margin, the Stock Exchange is responsible for eliminating these risks, and there are several ways to deal with it. Most trading floors with derivatives decided to create an insurance fund to manage executions.
This insurance fund earns from liquidation operations that have performed better than bankruptcy rates, creating a suspicious incentive to more actively manage these orders. This situation can be easily avoided with a stop loss, although most traders do not.
Let’s take a quick look at how BitMEX managed to accumulate this impressive $ 330 million bank during the massive liquidation events, and how to avoid becoming a victim.
Filter engines protect metabolism
In fact, high-leverage orders went bankrupt in volatile markets. For example, any position that uses 20x or higher should be aggressively filtered after 4.8% discount. The problem arises when the price of the underlying asset changes rapidly during a short period of time or as a result of a lack of liquidity in the market.
The only way the settlement mechanism can close a customer’s bankruptcy position is to execute a reverse order in the market for the instrument itself. An account of $ 10 million in a long position means that the derivative exchange must sell this amount in the order book. Any deliberate loss of the customer’s margin will give the exchange a shortage of funds.
This allows you to exchange bitcoin derivatives with the possibility of either withdrawing part of the profit from clients who have benefited from this error (known as refund or automatic division), or risk this risk, risk, waiting for the market to recover after the volatility rises.
Some exchanges designed their insurance fund to have some reserves for these financial restrictions, and to collect liquidation profits that showed better results than the bankruptcy price for clients.
Not all derivatives exchanges deal with liquidation in the same way, but the gradual settlement process that many larger exchanges use is definitely a step in the right direction. This is because a more proactive approach increases the likelihood that the exploited position will remain in very precarious situations.
How to avoid stability
First of all, traders should not allow automatic adjustment mechanisms. The only way to do this is to manually enter the stop loss. Most derivative exchanges provide an approximate price for each position, so it is not difficult to do so.
In the above example, the liquidation price for this long position is $ 3227. A trader should place a Sell Stop order above this price to avoid reckoning, and it is also best to gradually reduce position to prevent positions with high volatility.
There is no golden rule for this stop loss level, although price difference of $ 50 to $ 300 is used. A long position stop loss is a sell / sell order, while the short seller must place a buy order to reduce your position.
For stop loss orders you should always activate near the triggers, which are also called reducers. This will ensure that no additional center is created accidentally and only allows for such an order to reduce exposure.
Another parameter that is often forgotten is the trigger. There are three options: the final price, which depends only on the level of the forward contract, the index price, which is calculated with the average spot price of the reference exchange, and the brand price, which consists of the index price plus the interest rate.
The most recent price alternative should be avoided, as futures contracts may differ from the prices of the underlying assets.
Act safely by controlling volume
The use of excessive leverage when trading future contracts exposes the capital to unnecessary risk, and some exchanges collapse strongly. To prevent this scenario, you can actively manage the situation and its position.