Leverage can help amplify returns, but at the same time, it can amplify losses, leading to liquidated accounts. While leveraged trading is a mainstay part of trading across any market, traders have to appoint close loss-protection strategies to execute failsafes. While loss prevention strategies can be effective, they can be out of reach of most novice traders and, more notably, can often be difficult to execute in the Crypto sector.
Interestingly, leveraged exchanges in Crypto have no interest in protecting users from liquidation as exchanges profit from liquidation fees and penalties. However, the industry’s largest exchange, Huobi, has such a diversified revenue stream that it can afford to prioritize user fund protection over revenue, and it has therefore launched mechanisms to protect user funds in case of liquidation.
One of the mechanisms is executed through Partial Liquidation on Huobi Futures.
Huobi Futures to Significantly Reduce the Risk of Liquidation
A bit of a background: Huobi Futures is a cryptocurrency derivatives exchange offering quarterly, weekly and bi-weekly contracts for 9 of the top cryptos like BTC, ETH or XRP and plans to add perpetual futures contracts soon.
Currently, the platform allows traders to use up to 20x leverage on contracts and offers a wide variety of trading orders like limit, trigger, IOC or FOK orders. The exchange has highly liquidity, with up to $2.5 billion in daily trading volume.
When a trading position is highly leveraged, there is a big risk of liquidation, an automatic process that will liquidate (terminate) your current position when a position cannot maintain margin requirements. A trader can minimize the risk of getting liquidated by not using leverage or having a low maintenance margin percentage.
This is why Huobi Futures introduced a novel liquidation system called Partial Liquidation, with no fee, which, according to the announcement, will help reduce the risk of a full liquidation thanks to a partial liquidation mechanism where user’s positions are reduced ‘in tier to the upper limit of the lower grade by liquidating positions partially and calculating its corresponding margin ratio’.
Although this sounds quite complicated, it’s not. Huobi will make use of the table below to reduce positions gradually instead of liquidating all of them at once. A full liquidation only occurs when the margin ratio is not greater than 0 at grade 1.
To better understand how partial liquidation works, let’s use a simple example where a trader holds a 5,000 BTC futures position with a 10x leverage. Looking at the table above, this would put the trader at tier 2 with a 10% adjustment factor and a 1% maintenance margin ratio.
According to the system, the trader’s position will be degraded to Tier 1 which starts at 999 BTC and will only liquidate the 4,001 BTC if the margin ratio is larger than 0%. Eventually, the position will be fully liquidated if needed. A trader that has 100,000 BTC or more in a position will have to go through 4 tiers before full liquidation.
It’s also important to note that Huobi will not be charging fees when a position is partially liquidated and that the current adjustment factor can be changed in the future.
The Huge Risk of Leveraged Trading and Liquidations
Over the past years, more and more cryptocurrency exchanges have started offering the ability to leverage your trading positions, usually up to 100x. There have been some huge liquidations in the past that you can even find Twitter accounts solely dedicated to tracking large liquidations. In fact, according to data from skew.com and datamish.com, around $20 billion got liquidated on BitMEX in 2019 alone.
The biggest liquidation was over $100 million and although we don’t know for sure the amount of leverage used, assuming an average between 20x and 30x leverage, someone lost up to $3-5 million in a single trade.
Another ridiculous liquidation event happened during May 2019 when a huge barrage of sell orders on Bitstamp destroyed the price index on BitMEX which led to over $225 million in liquidations.
Liquidations are especially present in the cryptocurrency market due to its volatile nature. It’s not rare to witness 5-10% price moves within minutes due to low liquidity and high market manipulation.
Leveraging in the crypto industry has been under a lot of scrutiny from various regulatory bodies in the world, most notable the FSA in Japan which limits leveraging to just 2x. At the same time, volatility in the market is also fueled by leverage and it becomes a vicious circle. These aspects have been largely ignored by platforms as they have profited from liquidation. BitMEX, for example, has used liquidation fees to charge its users over $300M in penalties. The status quo places liquidation of users in the interest of the exchange.
Huobi Futures’ Partial Liquidation will offer a default protection mechanism for users’ funds, a highly needed prospect that can hopefully generate the spotlight needed to sway prioritization towards users’ fund safety.
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