When the mark price reaches the trader's liquidation price, the liquidation engine overtakes and closes the position. As the liquidation occurs, the engine aims to prevent loss of the position by closing at the bankruptcy price. However, in volatile or non-liquid markets, contract losses may be caused due to an inevitable close at a price worse than the bankruptcy price. In general, when these contract losses occur, positions are managed by the contract loss mechanisms, including socialized loss and auto deleveraging (ADL) systems.
Auto Deleveraging(ADL) vs Socialized Loss
Socialized Loss
Socialized Loss is a mechanism where all the traders on the platform compensate for a contract loss. If the insurance fund does not cover the contract loss, the socialized loss is triggered. This means that a single risky trader with high leverage will cause risk to all traders with positions on the platform, including low risk/risk-averse traders.
MCS implements the auto deleveraging system as the contract loss mechanism as it is more benevolent to many traders on the platform when considering socialized loss. In addition, MCS manages the insurance fund flexibly and reliably to minimize auto deleveraging occurring.
Auto Deleveraging (ADL)
Auto Deleveraging (ADL) is a contract loss mechanism that is activated when a contract loss occurs and the insurance fund is not sufficient to compensate for the loss. If ADL is triggered, the trader's position will be compensated by auto deleveraging the positions of traders with high ADL ranking. The system therefore only affects some of the traders who use high leverage and/or have high returns. This protects other traders who use low risk and low leverage from being harmed by a single risky trader.
Traders can view their ADL Ranking to manage their own risk of being auto deleveraged and reduce ADL Ranking by decreasing leverage used or by closing some of the positions. If a trader is auto deleveraged, they will be notified and all active orders will be canceled automatically.
<Auto Deleveraging Example>
David goes long 10,000 BTC/USDT contracts at 9,000.50 USDT with 10x leverage and has a liquidation price of 8,373 USDT.
\begin{align}\small \textsf{Long Position Bankruptcy Price} & \small = {{\textsf{Avg. Entry Price} \times \textsf{Leverage}} \over \textsf{Leverage + 1}} \\&\small= \textsf{9,000.5}\times{\textsf{10}\over\textsf{10+1}}\\&\small= \textsf{8,182.27273 USDT}\\\tiny\\&\small≈\textsf{8,183 USDT}\end{align}
The position is auto deleveraged if the liquidation engine fails to settle for a price better than 8,183 USDT (bankruptcy price) and the loss from the position cannot be covered by the insurance fund.
Assuming six short positions as shown in the table below, traders will be auto deleveraged in the order of their ADL ranking. Positions selected for ADL are deleveraged at Trader A's bankruptcy price.
According to the table above, Trader A's ADL ranking is the highest, therefore 10,000 BTC/USDT contracts are matched at 8,183 USDT (bankruptcy price of the position being liquidated) and the remaining 200 contracts remain in position. After auto deleveraging, Trader A has a relatively small number of contracts with the same margin, which lowers ADL Ranking. Similarly, if 15,000 contracts are to be auto deleveraging, traders A, B, C, and D will all be selected.
ADL Ranking
ADL ranking is a ranking that indicates the possibility of being auto deleveraged when the ADL System is invoked. It consists of 5 different ranks where each light represents a 20% increment to the next percentile. When all the lights are on, that means that the trader is at the top percentile of the auto deleveraging queue. Therefore, the possibility of auto deleveraging of the trader's position can be minimized by reducing leverage to lower their ADL Ranking, or by partially closing the position to reduce the quantity exposed to auto deleveraging.
ADL Ranking Equation
Case 1:
when \begin{align}\scriptsize \textsf{PNL Percentage}= {{\textsf{Avg. Entry Price}\over\textsf{Mark Price}}-1} > 0 \end{align}
$$\small\textsf{Ranking Score} = {{\textsf{Bankruptcy Price}\times{(\textsf{Avg. Entry Price}-\textsf{Mark Price})}}\over{\textsf{Avg. Entry Price}\times{(\textsf{Bankruptcy Price}-\textsf{Mark Price})}}}$$
Case 2:
when \begin{align}\scriptsize \textsf{PNL Percentage}= {{\textsf{Avg. Entry Price}\over\textsf{Mark Price}}-1} < 0 \end{align}
$$\small\textsf{Ranking Score} = {{{(\textsf{Bankruptcy Price}-\textsf{Mark Price})}\times{(\textsf{Avg. Entry Price}-\textsf{Mark Price})}}\over{\textsf{Bankruptcy Price}\times\textsf{Mark Price}}} $$
Insurance Fund
The Insurance fund exists to protect traders against contract losses and to minimize the triggering of auto deleveraging (ADL). If the final closing price* is worse than the bankruptcy price, the insurance fund covers the loss instead of triggering the auto deleveraging system. MCS transparently manages the insurance fund, and traders can view the current insurance fund balance and details on MCS's insurance fund page and widget.
*Final Closing Price: The price at which the liquidating position is actually filled when the position is liquidated.
Insurance Fund Logic
All positions have a liquidation price and a bankruptcy price. The liquidation price is the price at which liquidation is triggered. When the value of the position reaches the bankruptcy price, all margins on the held position are zero. If the final closing price of the position is better than the bankruptcy price, the balance remaining after the liquidation is added to the insurance fund. Conversely, if the final liquidation price is worse than the bankruptcy price, a contract loss is incurred, which is covered by the insurance fund. If the amount of insurance funds is insufficient to cover the contract losses, the ADL system will be activated.
<Insurance Fund Logic Example>
David is long in BTC/USDT contracts with a liquidation price of 12,500 USDT and a bankruptcy price of 12,000 USDT. If the Mark Price reaches 12,500 USDT, the trader's position is liquidated. If the final closing price is 12,300 USDT which is higher than the bankrupt price of 12,000 USDT, the remaining margin will be transferred to the Insurance Fund. However, if the final closing price is 11,500 USDT, which is lower than the bankrupt price of 12,000 USDT, then the contract loss due to the position liquidation will be compensated by the insurance fund.
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