Bitget Exchange: ADL System, Example and Uses
The following article sheds some light on the Auto-Deleverage system (ADL system), which is an exchange mechanic that comes into play when a trader is forced to liquidate its position. The cryptocurrency market has always been volatile, and liquidation of leveraged positions happen very often. A common concern of many leveraged traders is: If there is a contract loss during a liquidation, then who on the exchange will cover it? The ADL system was designed to cover that loss after a liquidation with a contract loss cannot be covered by the Insurance Fund.
A whale trader is holding a large position with extreme leverage and speculating for an uptrend market, thus is positioned long. One day, the market retraces, and his position is liquidated. The contract loss would be any extra loss that his initial margin could not cover.
To cover this loss, there are 2 common ways exchanges deal with such an event. One is a socialized loss system, that spreads that loss proportionately to all profitable traders. With this system, a single risky trader can create a large contract loss for all profitable traders, including those that trade with low risk. This is why this system is generally seen as unfair, as it forces low-risk traders to cover the loss of high-risk traders. Mass liquidations further increase the problem as it might affect most traders on the exchange, which in turn can cause liquidity issues overall.
ADL on the other hand automatically deleverages opposing traders`s positìons by profit and leverage priority. This means that the chances of getting auto-deleveraged increase if a trader has a more profitable position with a high effective leverage.
This makes the ADL system more fair than a socialized loss system for low-risk traders as they have a lower chance to be selected.
How does the ADL system work?
The ADL system selects and prioritizes traders with the highest ranking to deleverage. The ranking is based on highest profits and effective leverage used. The system then matches the selected profiting positions with liquidation orders. The trader covering for the loss pays a Maker fee, and the trader whose loss was covered, a Maker fee is being rebated.Traders who experience an ADL will receive an e-mail of phone notification and have all of their active orders closed.
A trader longs 10.000 contracts BTCUSDT at a price of $20.000. Lets assume the liquidation price is set at $19.700 and a bankruptcy price at $19.500.
When mark-price hits liquidation price, the 10.000 contracts are forcefully liquidated (forced liquidation). However the current contract. However, the current last traded price on the exchange itself is $19.200, which is much lower than his bankruptcy price. In case of insufficient balance in the insurance fund, the loss will be covered by putting the ADL mechanic to use.
There are 3 short positions on the exchange:
Traders Short position Ranking (PNL + Leverage) Precentile
Edward 20.000 contracts 6 20%
Susanna 15.000 contracts 4 60%
Jade 40.000 contracts 1 100%
Looking at the above positions. Edward has the highest ADL ranking, as he uses the most leverage and has a high PNL coming from that position. Edward will be selected to cover the 10.000 contracts loss at $19.500 bankruptcy price. Edwards position will be effectively deleveraged by having the ADL system close 10.000 contracts. After this event, Edward will not be ranking at the top percentile anymore.
Similarly is there were 75.000 contracts worth of loss, then Edward, Susanna and Jade altogether will be selected, and will receive a notification that all of their active orders are closed. After which, they are free to re-enter the market at their earliest convenience.
The ADL system will often kick in as a last resort, as most exchanges nowadays have an insurance fund, which first must be depleted before the ADL system automatically takes over.
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The information provided above is not financial advice but for educational and entertainment purposes. Please do your own due diligence or consult a financial advisor before investing in any digital assets.
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