How Does Auto-Deleveraging (ADL) Work and Why Does an Exchange Try to Avoid It?
Auto-Deleveraging is a mechanism used when the insurance fund is insufficient to cover losses from a bankrupt position. The exchange forcibly closes profitable positions of opposing traders to cover the shortfall.
Profitable traders are ranked by profit and leverage, and their positions are closed at the bankruptcy price of the losing trade. Exchanges avoid ADL because it is highly disruptive, causes uncertainty, and can erode trader confidence by forcing profitable positions to close unexpectedly.
Glossar
Insurance Fund
Mitigation ⎊ An Insurance Fund, within cryptocurrency and derivatives markets, functions as a capital reserve designed to absorb losses stemming from systemic risk or counterparty default, particularly relevant in decentralized finance (DeFi) protocols.
Trader Confidence
Conviction ⎊ Trader confidence, within cryptocurrency, options, and derivatives, reflects a quantifiable assessment of prevailing market direction and the probability of sustained price movement, influencing position sizing and risk parameter calibration.
Profitable Traders
Discipline ⎊ Consistently profitable traders in derivatives markets exhibit superior risk management discipline, strictly adhering to predetermined stop-loss levels and position sizing protocols.
Bankruptcy Price
Threshold ⎊ The bankruptcy price represents the critical market level where a leveraged derivative position's collateral value precisely equals the outstanding debt and accrued fees.