Most contract traders have heard about forced liquidation even before they started to trade crypto contracts. The term refers to scenarios in which the investor has lost virtually all of his/her principal under extreme market conditions. Bankrupt positions, which are even worse, mean that the market price falls below the liquidation price under extreme market conditions even before the position is liquidated. In such cases, the available balance in the investor’s account is a negative figure, meaning that the investor not only loses all of his/her margins but also, in theory, owes a debt to the trading platform.
In a conventional futures contract market, market volatility and leverage are comparatively low. However, the risk of bankruptcy still exists in extreme cases. In the crypto market, where the volatility and maximum leverage are higher, contract traders are more likely to go bankrupt. For example, if an investor goes long on Bitcoin with a liquidation price of $35,000, under significant market swings, there may not be that many makers willing to buy at $35,000. As such, the price will soon fall below the liquidation price. At this point, the position could not be settled at a price higher than the bankruptcy price even before it is liquidated. Therefore, the losses would exceed the total margin. In such scenarios, the positions are bankrupt.
What should we do with the bankruptcy loss? On CoinEx, bankrupt positions are handled by the Insurance Fund. When investors go long and the liquidation price is lower than (to a certain extent) the bankruptcy price, or when investors go short and the liquidation price is higher than (to a certain extent) the bankruptcy price, the excess will be borne by the Insurance Fund, which is funded by the surplus generated by the forced liquidation of contracts. On CoinEx, when your assets are liquidated, the system will sell them at the bankruptcy price on the market through matching; if the execution price is higher than the bankruptcy price, the surplus will go to the Insurance Fund.
Under an approach, the bankruptcy loss is covered by the insurance fund. If the funds in the Insurance Fund run short, Auto-Deleveraging (ADL) will step in and cope with the bankrupt positions. So far, CoinEx’s Insurance Fund is backed by a large amount of funding. The detailed daily uses of the funds are available on the platform, and ADL is less likely to be triggered.
However, not all exchanges use the insurance fund to pay for the bankruptcy loss, and some of them have adopted a mechanism called clawback, which means that all traders who have profited must bear the bankruptcy loss when some traders fail to liquidate their positions in time. For example, when the position of long traders goes bankrupt, the loss will be borne by short traders according to the clawback rate.
Clawback reduces the profit received by other investors. Therefore, comparatively speaking, it is more reasonable to cover the bankruptcy loss with funds in an insurance fund, which is also more investor-friendly. Moreover, platforms backed by a large insurance fund also promise more satisfying trading experiences — You do not have to worry about the reduction of profits as a result of ADL.