On March 7, BitVC will end the policy of socialized system losses and implement a new method of forced liquidation risk management for bitcoin futures - automatic counterparty deleveraging.
In order to offer high-leverage bitcoin futures trading while managing systemic risk, BitVC and the other major bitcoin futures exchanges have followed a policy of proportionally allocating system losses from forced liquidations at contract settlement time. This is commonly referred to as socialized losses. While this policy has succeeded in preventing insolvency (ensuring that cumulative profits equal cumulative losses for each contract) during periods of extreme volatility, as it was designed to do, it has also been unpopular with many users. Now we have designed an alternative which will eliminate the need for socialized losses.
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. Under the socialized loss system, these negative account balances were covered by deducting the negative balances proportionally from profits at contract settlement time. Under the new system, if a forced liquidation is triggered and there are insufficient 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 that the liquidation order can be filled at the target price, thus preventing negative balances from occurring and eliminating the need to socialize losses at contract settlement time. This will affect fewer users and they will be notified immediately if automatic deleveraging occurs (allowing the opportunity to compensate for the reduction in position size), rather than have to wait until contract settlement to discover the amount of socialized losses.
Automatic counterparty deleveraging protects BitVC from systemic risk while eliminating socialized losses for our traders. This solution is not perfect, but we believe it is a significant improvement over any other risk-management strategy for a high-leverage bitcoin futures trading platform.
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