Industry experts believe that digital currencies may positively impact the current financial system. Even so, cryptocurrencies are still prone to drastic price swings, which can open up several risks, such as liquidation. In the financial market, liquidation refers to the act of closing a trading position. Investors commonly use the term in the margin trading strategy.
Liquidations in Crypto: The Back Story
In most cases, investors may opt to borrow money from a brokerage firm to buy assets. This decision can lead to two extreme scenarios where investors can either maximize profits or lose their leverage and capital. The crypto world is no different as it involves closing all positions if specific trading requirements are unmet. Below is a clear insight into what liquidation means in the digital currency ecosystem.
Liquidation in the Context of Trading
Liquidations in the crypto economy take place in the capacity of any margin trading strategy. As mentioned earlier, margin trading involves borrowing money from a third-party firm to acquire assets. However, crypto investors use exchanges instead of borrowing funds from brokerage platforms to increase their positions.
When investors need to boost their leverage, an exchange will advise them to submit a certain amount of collateral (initial margin). Hence, the collateral acts as an insurance fund for the trading platform if the trade becomes unsuccessful. Exchanges offer different leverage amounts, which could be ten times higher than an investor’s capital.
The strategy also requires investors to set up a threshold that matches the initial margin. That way, exchanges can liquidate investors’ positions when the margin is lower than the threshold level. At this point, the exchange will trigger a margin call that allows traders to deposit more funds on the margin. Margin calls help investors adhere to the agreements and avoid liquidation.
A Closer Look at Liquidation as Bankruptcy
Recent data shows that 20,000+ traders face liquidation within the last 24 hours, bringing the total liquidation amount to $90.79M. The ongoing market crash is undoubtedly creating uncertainties in the global crypto market. A number of platforms are filing for insolvency as the world struggles to stabilize the economy. Examples of these platforms include:
Three Arrows Capital
A Singapore-based hedge fund Three Arrow Capital recently received a liquidation order from a court in the British Virgin Islands. From the start, 3AC adopted a trading strategy that placed leveraged bets on various digital assets. The fund managers also had bullish sentiments on virtual currencies such as Bitcoin, Luna, and Terra USD. Despite that, 3AC was ordered to liquidate its assets and repay creditors.
In light of this occurrence, the BVI court-appointed a consulting firm Teneo to oversee the liquidation. The firm is responsible for safeguarding 3AC’s assets and determining its creditors. As such, Teneo plans to design a website that allows creditors to claim their debt.
Among the creditors pursuing 3AC include platforms like Voyager Digital and Kyber Network. Voyager Digital, a public trading platform, allegedly claims that 3AC failed to honor a Bitcoin loan worth more than $300M.
Kyber Network, on the other hand, admits that 3AC avoided communication since the fund handles $7.9M of Kyber’s treasury. The distrust made Kyber move to court and seek legal assistance against Three Arrows.
Celsius is yet another platform that could encounter total liquidation. The lending protocol temporarily disabled digital coins’ transfer, withdrawal, and swapping in June 2022. According to Celsius, halting these functions is a strategic move that can stabilize liquidity and meet several obligations.
As of May 2022, the lending protocol managed close to $11B in assets. As such, pausing these options enables Celsius to protect the community’s investments as it figures out its next move.
A tweet from the BlockFi CEO Zac Prince shows that the lending platform successfully liquidated Three Arrows in June 2022. Following BlockFi’s remarks, liquidating 3AC was necessary since the hedge fund failed to meet its collateral requirements.
Concluding the list is Vauld, a Singapore-based exchange platform. The lending protocol managed to block various functions such as trading, deposits, and withdrawal of assets. By mid-June 2022, Vauld settled withdrawals worth $197M even with the dwindling economy.
Vauld shut down these options citing financial struggles resulting from the global market crisis. At the time of writing, Vauld is exploring financial and legal assistance to satisfy the needs of its customers.
Applying for a moratorium is one alternative that it intends to pursue. The moratorium will help create time to find an appropriate liquidation solution before any lawful action is taken. In terms of financial advice, Vauld plans to engage with Kroll Pte Limited to find the right restructuring option.
Liquidations in the crypto world can adopt two types of approaches. One concept can explain a platform’s bankruptcy, while the other highlights how it affects an investor’s trading position. Depending on the context, the total liquidation of cryptocurrencies can either lead to marginal losses or disrupt a platform’s operations.