On exchanges that offer trading on margin there will be liquidations. If a trader works with ten times leverage and the price moves ten percent against him, there will be a margin call and the position gets liquidated. Now these exchanges usually operate on a peer-to-peer-system. That means, not the exchange provides the funds for leveraged trading, but the other traders. If a position is liquidated, the margin of the trader will be used to cover this. If a long position gets liquidated it will be automatically market sold and vice versa. Now every once in while there will be a whale in the gold fish pond who opens massive positions which – in case of liquidtaion – bust all orderbooks. This is a problem and an enormous risk for the market.
In August 2018 there was a case like this. On the spot- and derivative-exchange OKEx there was such a “whale”. End of July the risk managment alarm system of OKEx wstarted ringing, because this whale opened a huge long position. More than 4 million contracts made the risk managment team contact the anonymous trader and ask him to at least partially close the position to reduce the overall risk for the market. The trader refused and so OKEx decided to freeze the position. Shorty after Bitcoin tumbled and the position had to be liquidated.
OKEx immediately injected about 2500 Bitcoin (about 18,5 Million Dollars at the time) in its insurance fund to mitigate the losses. But since the insurance fund wasn’t enough to cover the position, the OKEx “claw back system” (https://support.okex.com/hc/en-us/articles/360000139652-Forced-Liquidation) was triggered. That means all losses that weren’t covered by the insurance fund were “socialized”. The missing amount was taken from the unrealized profits of all open short positions. In this case every open short position had to take a cut of 18%. This system is obviously not ideal and led to massive inflation of insurance funds on some exchanges. This comes with risks of itself. More on this topic in “the Art of liquidation: Part II – The BitMex Insurance Fund”.
This socializaton of losses reminds of the crash of 2008, when the losses of the high finance were socialized and had to be covered by the public. The gouvernments made the taxpayer pay hundreds of billions of dollars to bail out the banks. The high finance was of course allowed to keep the profits and boni made in the decades before.