The Art of Liquidation: Part III – The BitMEX Insurance Fund

In the last two episodes we learned that some exchanges tend to socialize losses from big liquidations. The traders on the exchange have to take a haircut, the loss is carried by many shoulders and the exchange can keep on operating. That works, but it is not fair. Users that have not caused the loss have to take it. It reminds of the bailout 2008. The taxpayer had to bail out the system-relevant banks that were “to big to fail”. With hundreds of billions of dollars.

The BitMEX Insurance Fund

There are exchanges that prepare for these big liquidations. They create an insurance fund. Should highly leveraged trades, which bust all orderbooks, be liquidated, the insurance fund will be triggered. That prevents big liquidations from endangering the whole system. But if the insurance fund becomes to big, it becomes system-relevant itself. Should the exchange be closed or hacked and the insurance fund hits the market, it would be a crash of epic proportions. The BitMEX insurance fund is such a case. By now it holds about 0,15% of all Bitcoins – worth about 232 million dollars. The fund would be ranked 33 on the bitcoin rich list (#1 is Satoshi Nakamote, the founder of Bitcoin with about 900k Bitcoins, #2 is the FBI with about 150k Bitcoins in their wallets). A concentration like this is always system-relevant.

The BitMEX Trading Desk

But the sheer size of the fund is not the only problem. BitMEX runs a trading desk itself – trading against its own customers. And of course they have an informational advantage, because since they run the exchange they see every order and know the exact point of liquidation for every order. They know exactly how much capital they need, to drive the price into this cluster of liquidations. If the bid/ask-spread is smaller than the maintenance margin of a leveraged position, then the money from the liquidation will be added to the insurance fund. So BitMEX has a motive to liquidate its customers. But that’s not all.

Order Submission Errors

Everybody trading on BitMEX knows the dreaded Order Submission Errors. If price becomes volatile, the engine closes down and no more orders can be placed. BitMEX is a multi-billion-dollar-company and one should assume, that they should be able to build an engine that also works on high payload. And that’s why some critics say that these Order Submission Errors are no bug, but a feature. Because the BitMEX trading desk (and maybe some premium customers) get a time advantage, where they can place their orders without rush, while everybody else is shut out. Conclusion The fact that BitMEX trades against its own customers is not only dubious but highly unethical. And a system-relevant insurance fund coupled with a team with questionable ethical standards is a threat for the market.

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