The Art of Liquidation: Part IV – The Invisible Tentacle of the Markets
Welcome to “The Art of Liquidation: Part IV”. In the last few episodes we learned how various crypto derivative exchanges handle extremely large liquidations, which are potential threats to the market. OKEx and Poloniex socialize the losses, Bitmex has an insurance fund that has become systemically relevant itself due to its sheer size. What is Kraken’s approach?
Maintenance Margin on Kraken
Let’s look at the liquidation model of the exchange “Kraken”. Unlike the exchanges previously examined, Kraken does not have a P2P margin model. It is not other users who borrow the funds but Kraken itself. If the maintenance margin falls below 40% the position will be liquidated automatically. At 80% there is a margin call and Kraken reserves the right to liquidate below 80% in extreme market situations.
Such extreme situations would be, for example, massive volatility, which is not uncommon on the crypto market. Since Kraken provides the funds itself and has to carry the losses, it is understandable that they operate a tight maintenance margin system. Otherwise large liquidations would be endangering Kraken itself.
The Instant Margining System
The risk for leveraged futures on the platform is managed via the so-called “Forced Liquidation” process in the “Instant Margining System“. If an extremely large position is liquidated, which bursts the Oder books, it is called “Unfilled Liquidation” and triggers the following: The Unfilled Liquidation is transferred to a “Liquidity Provider”. This is a market maker who has unlimited liquidity and can therefore handle liquidations of any size.
This is an emergency mechanism that only triggers after the order books have been emptied. According to Kraken, this happens on average every 10,000 hours, i.e. less than once a year (about every 420 days).
So we see Kraken is not organized like other platforms in a P2P manner. It provides leverage and handles large liquidations with extremely liquid market makers.
It makes sense that Kraken itself would set a limit on positions that would exceed even this extreme liquidity, but that would probably be extremely high sums (probably at least eight or nine digits). One could categorize the Kraken model as centralized liquidation, unlike the other exchanges.