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Learn about Margin Trading
Margin refers to the money borrowed from a third party (such as an exchange) to invest. Specifically, it refers to the difference between the total value of the securities held in the user's account and the amount of the loan received from the lender. Margin Trading allows investors to control and use more assets than they actually own. It also requires investors to use assets they own as collateral in case investors cannot repay the borrowed funds. Typically, the borrowed funds come from other traders or exchanges. Capital amplification is very suitable for asset markets with low volatility to improve returns, and different markets have different rules and leverage ratios.
Usually margin trading can provide 2-20 times leverage purchasing power. This allows you to purchase a wider variety of assets, which can unlock more trading opportunities and improve overall returns. Margin trading also allows you to go short. This means that you can also make a profit when you think the price of an asset will fall.
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Insurance Fund System of Traditional Financial Companies
In the traditional securities and futures industry, futures exchanges generally withdraw a certain percentage of funds from the transaction fees collected by themselves as an insurance fund to ensure the performance of the exchange guarantee. The exchange should not only extract insurance funds from transaction fees, but also establish a special stock index futures insurance fund paid by members for the special risks of stock index futures. The stock index futures special insurance fund can only be used to provide financial guarantees for maintaining the normal operation of the stock index futures market and to make up for losses caused by unforeseen risks of the exchange. The insurance fund must be accounted for separately, stored in a special account, and cannot be used for other purposes except for making up for risk losses.
For example, leveraged trading venues such as the Chicago Mercantile Exchange (CME) often have as many as five layers of protection to ensure that the winner receives the expected profit:
1. If the loss of an individual trader is greater than the collateral in his account, making his account balance negative, he needs to inject more funds into his account to recharge the position. If they are unable or unwilling to do so, their broker can file a lawsuit against the trader to force the trader to provide funds or file for bankruptcy. Every trader must use a broker, who can assess each client's balance sheet and capital to offer each client a customized amount of leverage based on an assessment of their specific risks.
2. In the traditional derivatives market, traders usually cannot directly enter the trading platform. Instead, clients enter the market through a broker (clearing member), such as an investment bank such as JPMorgan or Goldman Sachs. If the trader suffers a loss and cannot collect the debt, the broker must pay the exchange fee to cover the counterparty's profit. From an exchange perspective, these brokers are sometimes called clearing members.
3. In the event of default by a clearing member, the centralized clearing entity itself is usually required to make the counterparty a whole. In many cases, clearing and settlement are performed by a separate entity to the party operating the exchange. Clearing houses typically have various insurance funds or insurance products that fund clearing members.
4. If a clearing member is unable to clear and the centralized clearing entity does not have sufficient funds, in some cases other solvent clearing members should provide the funds.
5. Financial regulators generally consider many large clearinghouses (and possibly even large brokers) to be systemically important to the global financial system. So when the day of reckoning comes, a major clearing house could fail and the government could step in and bail out traders to protect the integrity of the financial system. Typically in the interest rate swap market, traders and institutions often have large notional positions (trillions of dollars) that are hedged against other positions or instruments. Therefore, it is important that the large clearinghouses remain solvent, otherwise the entire financial system could collapse.
From the official description of CME, we can find the contributors of various insurance funds:
CME offers
Clearing members provide
Bonds issued by clearing members, which can be redeemed by the clearing fund in case of member default
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Insurance Fund System for Cryptocurrency Centralized Exchanges
Centralized cryptocurrency trading platforms such as BitMex and Binance currently cannot provide the same protection for winning traders as traditional exchanges such as CME, because most traditional financial exchanges use a broker system, restricting access to retail customers, through brokers assessment, giving different access rights and leverage multiples. While cryptocurrency is a retail-driven market, customers expect direct access to the platform. At the same time, crypto trading platforms offer the ability to limit downside risk, which is attractive to retail clients, so crypto exchanges don’t chase after customers and demand payments from those with negative account balances.
The essential reason for the existence of the insurance fund lies in the insolvency caused by the collateral in the forced liquidation. And because of the different collateral, there will be three reasons for insolvency:
The average price of forced liquidation triggered by liquidity depletion is worse than the bankruptcy price
Changes in the price of the collateral itself cause the value of the collateral to be smaller than the profit taking, so the liquidation price is worse than the bankruptcy price
Slow or delayed price response to extreme market conditions
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Stablecoin-based futures contracts
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Source of Insurance Fund
In the above example, the winning trader Alice expects to make a profit of $1900. At this time, the loser Bob is lower than the maintenance margin ratio, triggering a liquidation order, and the system is forced to close this short position with a worse market price (higher than the market price) position, due to the lack of market liquidity, the last average transaction price was $2210. In the end, Bob's position actually lost $2100, which was more than the collateral he put up for the transaction (only $2000 worth of USDT). Therefore, it is necessary to withdraw $100 from the insurance fund and distribute it to Alice, so that the winner Alice can actually get the actual profit of $2100 ($2000 of the collateral and $100 of the insurance fund).
If the liquidity is sufficient, the margin after the liquidation will be the rest
Exchange official injection
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Insurance Fund System of Decentralized Derivatives Exchange
With the vigorous development of decentralized finance, DeFi has also extended from spot exchanges to derivatives exchanges. Unlike centralized exchanges, decentralized derivatives exchanges have a greater impact on the source of insurance funds and working mechanisms. s difference. The following will take Injective and DerivaDex as examples to introduce the insurance fund operation mechanism of derivatives DEX.
Injective Protocol
Injective Protocol is the world's first Layer-2 derivatives DEX, which supports users to trade any type of derivatives, unleashing the full potential of borderless decentralized finance. Injective has received the support of many institutions, including Pantera Capital, one of the world's top cryptocurrency venture capital companies, and Binance, a leading cryptocurrency exchange, and has just recently launched the mainnet launch and the pledge function of the insurance fund.
The initial capital of the insurance fund comes from independent underwriters, and the underwriters (Underwriters) assume the risk of the insurance fund in the derivatives market by mortgaging tokens (such as USDT). Then, when a transaction occurs in that market, the insurance fund may increase or decrease depending on the liquidation behavior of that market. The amount of the insurance fund will grow when the liquidation price > the bankruptcy price, i.e. the position is liquidated above the bankruptcy price. The opposite situation is, if the closing price< Bankruptcy price, funds will be withdrawn from the insurance fund. In order to incentivize underwriters to pledge underwriting, the innovation of Injective is that when a user underwrites the derivatives market, he pledges funds for the market, and then obtains the insurance pool tokens dedicated to the market. These insurance pool tokens represent proportional ownership of the insurance fund. Therefore, as the insurance fund grows from liquidation proceeds, insurance fund owners will benefit from the increase in the value of their insurance fund equity. Correspondingly, if the insurance fund loses in liquidation, the insurer will also bear the share corresponding loss.
Another innovation is that Injective's insurance funds are market-specific. That is, there is no public pool of insurance funds, and a new insurance pool exists for every derivatives market launched on Injective. In this way, the risk-taking of the insurance pool is distributed to each independent market. Typically, riskier markets tend to have higher staking reward rates to compensate users for the high risk they take.
DerivaDEX
DerivaDEX is a decentralized derivatives trading protocol based on Ethereum. It was founded by Aditya Palepu, a former quantitative trading company DRW quantitative trader, and Frederic Fortier, a former Enigma MPC senior software consultant. It is still in development before the release of the test network.
DerivaDEX (DDX) officially launched the insurance mining project in December 2020, and launched the governance of the decentralized autonomous organization DerivaDAO. Users can deposit stable coins USDT (ERC20), cUSDT, cUSDC, USDC, HUSD and GUSD through the website to participate The launch of the DDX Insurance Fund and the acquisition of DDX governance tokens, the support of other assets will be added through community governance.
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Comparison of insurance funds in CEX and DEX
Putting the centralized derivatives exchange and the decentralized derivatives exchange together, we can make a comparison of insurance funds. First, we compare the source of the funds, and second, we compare whether to share the profits of the insurance funds.
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The decentralized derivatives track is on the eve of explosion as a whole, and compared with traditional finance, it has also achieved a good degree of innovation. Derivatives provide a good tool for risk hedging and hedging for the digital asset market. Insurance funds play a certain risk control role in preventing financial risks, but it does not mean that investing in digital asset futures is risk-free. Digital assets are still high-risk , high-yield new wealth management products, hope that the majority of investors can fully predict the investment risks and invest rationally!
