Auto Deleveraging Liquidation
Auto-Deleveraging (ADL) Liquidation is a mechanism used to handle the liquidation of positions when there is insufficient liquidity to fulfil all liquidation orders. It is specifically applied in the context of leveraged trading, where traders borrow funds to amplify trading positions.
In traditional markets, when a position is liquidated, it is typically auctioned off to market participants to cover the loss. However, when there is not enough liquidity or available buyers to absorb all the liquidated positions, Auto-Deleveraging is used as an alternative method.
Activation Conditions
If the liquidation cannot be executed when the mark price exceeds the bankruptcy price, the ADL system automatically deleverages opposing trader positions by priority ranking. Auto-Deleveraging Liquidation is launched as a last resort when the Insurance Fund can’t cover the bankrupt position.
Auto-Deleveraging Liquidation will be activated under the following conditions:
- Insurance Fund is Depleted. i.e., Insurance Fund = $0
- If the backstop liquidity provider cannot take positions
Example
Trader A has the highest liquidity priority ranking, short position on BTCUSDT perpetual swap contracts with average entry price of 35,000 USDT.
ADL forces the positions below to be closed between each other at bankruptcy price of 30,000 USDT
- Long Position (qty = 1 BTC) from insurance fund account
- Short Position (qty = 1 BTC) from Trader A
The Insurance Fund will not be depleted since it has zero balance.
- Trader A could have closed a position at a market price $29,000.
- However, Trader A has been forced to close the position at $30,000.
- Therefore, he incurs an opportunity loss of $1,000.
- → P&L = 1 BTC * ($30,000 - $29,000) = -$1,000
Liquidation Priority Ranking
Flipster sets the liquidation priority ranking considering position profit and leverage so that the more profitable and higher leveraged traders are deleveraged with priority.
The priority ranking determines which positions are closed first during the liquidation process.
Here are some standard liquidation priority rankings:
- Highest Leverage or Risk: In this ranking, positions with the highest leverage or the greatest risk of losses are liquidated first. Traders who have taken larger leveraged positions and are closer to the margin limit are more likely to have their positions liquidated earlier.
- First In, First Out (FIFO): In a FIFO ranking, the positions that were opened first are liquidated first. This means the earliest opened positions are closed before the more recent ones. This method ensures fairness by treating all positions equally and liquidating them in the order they were initiated.
- Pro Rata: The pro rata method distributes the liquidation impact proportionally across all positions based on their size. Each position absorbs a proportionate share of the loss in this ranking, ensuring that all traders bear the liquidation risk equally.
- Others: Depending on the exchange or trading platform, additional ranking methods or variations in liquidation priority may exist. Some platforms may consider other factors, such as the amount of unrealized profit or loss, account equity, or a combination of different ranking mechanisms.
Liquidation Priority Ranking Calculation:
- P&L Percent = max(0,Unrealized Profit)/max(1,Wallet Balance)
- If (Wallet Balance+Unrealized Profit)≤0, then Margin Ratio = 0
- If (Wallet Balance+Unrealized Profit)>0, then Margin Ratio = Maintenance Margin/(Wallet Balance+Unrealized Profit)
- Leverage P&L = P&L Percent × Margin Ratio Leverage P&L = P&L Percent × Margin Ratio
- Leverage P&L Quantile = rank(user.Leverage P&L)/Total User Count
Risk Warning:
Trading in cryptocurrency involves risk and potential losses. Before trading, please make your investment decisions cautiously by considering your investment objectives, experience, and risk tolerance. You are solely responsible for your investment decisions, and Flipster is not liable for any losses you may incur. Derivatives trading, in particular, is subject to high market risk and price volatility. Please obtain independent advice where appropriate. This information should not be construed as financial or investment advice.