Futures trading platform BitVC has altered the way it handles forced liquidation risk management, replacing the ‘socialized system losses’ method that was sometimes unpopular with users.
The platform, a subsidiary of Chinese exchange Huobi, says it will implement a new method called ‘automatic counterparty deleveraging’.
A BitVC representative said the system is the first of its kind in the high-leverage bitcoin futures market and, while still not perfect, offers a significant improvement over other risk-management strategies in similar markets.
Automatic reduction of leverage
He went on to describe a situation in which the new method would be effective:
“When a trader’s dynamic equity falls to the forced liquidation trigger level, the system automatically closes his position. However, during periods of extreme market volatility, there may be insufficient counterparty buy or sell orders in the order book, resulting in a failure to complete the forced liquidation at the target price and a negative account balance.”
If such a forced liquidation is triggered and there are not enough counterparty orders to close the position, the system will automatically reduce the leverage of the most highly-leveraged open counterparty positions – by the amount necessary to ensure the liquidation order can be filled at the target price.
This prevents negative balances from occurring, and eliminates the need to socialize losses.
How socialized loss systems work
Socialized loss systems are in place at other leveraged trading platforms such as OKCoin. A method of managing systemic risk while still allowing highly-leveraged trading options, it proportionally allocates system losses from forced liquidations at contract settlement time.
Socialized losses incurred are revealed only after contract settlement, which does not allow for positions to be adjusted.
BitVC hopes automatic deleveraging will affect fewer users, who will be notified immediately if it occurs, allowing time and opportunity to compensate for the reduction in position size.
Unpopular with users
BitVC came under fire from some users in November under its old system, where a particularly volatile week in bitcoin prices saw it take 46.1% of successful traders’ paper profits to cover a 3,000 BTC ‘system loss’.
The system is designed to ensure the platform remains solvent by making cumulative profits equal cumulative losses when prices are volatile.
Although socializing losses is legitimate under the platforms’ terms and conditions, and BitVC agreed to reimburse its users with trading fee waivers, the size of the November loss shocked some and led to questions over whether bitcoin markets were liquid enough to handle more advanced professional trading features.
Risk management image via Shutterstock