BitMEX Liquidations: How to Avoid Getting Rekt

BitMEX Liquidation

For those Bitcoin traders who like to trade with leverage (and lots of it) they will most likely end up at BitMEX.

This exchange based in Hong Kong is well known in the Bitcoin community for being one of the most efficient and sophisticated Bitcoin futures exchanges on the market. With leverage up to 100x your initial investment, traders relish the high-risk, high return nature of the exchange.

However, BitMEX is a profit maximising futures exchange. Although they give traders the opportunity to make large returns on positions, they have become incredibly efficient at mopping up loose change. This easy money is handed on a plate to them by new traders who make silly decisions.

In this post we will take you through one of these bad decisions that you can easily avoid and reduce your chance of becoming liquidated or, in crypto lingo, “Rekt”.

BitMEX 101

Before we can take a deep dive on the nature of BitMEX order types, we have to give you a quick overview of BitMEX.

BitMEX (Bitcoin Mercantile Exchange) is a futures exchange that operates out of Hong Kong. It was started in 2014 by a team of ex investment bankers and traders. It is perhaps best known for being the first exchange to offer leveraged derivative products on Bitcoin.

These futures on BitMEX are not the regulated type that you have read about on the CME or CBOE. These are futures contracts that are traded on the open order books on the BitMEX exchange. They are not regulated and can be traded by any retail cryptocurrency trader.

BitMEX has grown substantially since their early beginnings and have rode the crypto wave more skillfully than most other exchanges. In fact, they recently broke a record for total volume of more than 1m BTC in a 24-hour period.

It’s safe to say, BitMEX is successful.

How BitMEX Margin Works

When you are doing any sort of leveraged trading on exchanges, you are required to put up margin for your account. These are required to make sure that the exchange or broker is not left holding the bag should the position quickly move against you.

Initial margin is required in order to cover the position of your futures contract. This initial margin is determined according to the amount of leverage that you have decided to take on. For example, if you are using 1:100 leverage then your initial margin is going to be 1% of your position.

When you place a futures trade on BitMEX, you are actually trading what is called a “limited risk” futures contract. Your losses cannot exceed the value of your initial margin.

This asymmetric payoff profile is one of the reasons that BitMEX is often chosen by traders. It gives them all the upside and limited downside. In fact, the payoff looks almost exactly the same as the payoff of a financial option. Below is a simple illustration of how the payoff looks.

Payoff of BitMEX limited Risk futures

How does BitMEX allow you such a favourable position?

This is because of the way they determine the Maintenance Margin Requirement (MMR). With usual brokers in traditional finance, when you breach your maintenance margin requirement, you will get what is called a “margin call”. However, BitMEX has something much more efficient and that is their Liquidation engine.

This is basically an automated system that will immediately close out positions that have already moved against the trader and have started eating into the initial margin.

What is the catch?

The relationship between the MMR and the initial margin is not constant and will vary arbitrarily according to the amount of leverage that one is taking on.

Liquidation price vs. Bankruptcy Price

BitMEX uses two prices that will determine levels for initial margin and the MMR. Your bankruptcy price is the price at which your initial margin has been exhausted and your loss from the position is 100%.

The liquidation price is the price at which you have exhausted your MMR and it is the price at which your position will be closed. This is done in order to protect BitMEX from the adverse and potentially harmful moves in the price of Bitcoin. You can read more about BitMEX liquidations here.

When you are placing an order, you will see your liquidation price as it presented in the order form. There is, however, no bankruptcy price being show to you upfront. This means that you can’t see how far the bankruptcy price is from the liquidation price and hence how much room your trade has to move from your complete initial margin.

Order forms with liquidation on Bitmex. Left with 100x leverage, Right with 1x. Image source: Bitmex.

By not showing you the difference between your bankruptcy price and the liquidation price, BitMEX is hiding away a secret edge that they have when it comes to high leverage contracts. That edge is the amount by which BitMEX will allow the trade to eat into the initial margin before they liquidate it.

This may sound like a bit of a mouthful right now but it helps to take a look at some examples as well as some actual numbers.

Statistical Edge

When your position is getting closed at a liquidation price that is further away from the bankruptcy price, you are being denied extra price participation and the chance for a market recovery. You are giving BitMEX the statistical edge in the long run even though a large proportion of your initial margin was not used.

It helps to take a look at some numbers in order to contextualize this. Below are the calculations for the bankruptcy price, liquidation price and the resulting margin rates. This is live data and you can monitor it yourself with this handy tool.

Liquidation and Margin Calculations on BitMEX. Image source: BambouClub.

What this shows is the amount of theoretical MMR you will have on a BitMEX long futures trade and how large this number is compared to the initial margin. This is all calculated by using the liquidation price given by BitMEX and the bankruptcy price which is calculated separately (based on the leverage).

From these two numbers, one is able to get an idea of the initial margin as well as the MMR that is being applied to that trade. As you can see in the second last column, the MMR is larger as you take on more leverage (as would be expected).

However, what is really interesting is viewing this relative to the initial margin. This is the last column in the sheet and this shows that for larger leveraged trades, the MMR makes up an increasingly greater percentage of the initial margin.

In the case of the 100x leverage trade, the position would have to move only $35 away from current prices and it will be liquidated. Hence, even though you have put up $70 in initial margin (price move from spot to bankruptcy), you will be liquidated when the price has only being moved to half of that ($35 MMR).

When you take a look at the numbers for the 10x leverage, the effect is way less pronounced. Your initial margin is $639 and you won’t get liquidated until the price has moved $609 away from the spot level. Hence, you are allowed to participate in a change in price that is almost 95% of your initial margin.

Put another way, the MMR of 10x leverage position is only 4.58% of the initial margin. This is more than 10 times below the 50% of initial margin MMR that is required for a 100x leveraged trade.

So, from a purely statistical perspective, the 100x or 50x leverage trade is not the most efficient trade to make and can in the long run give BitMEX the edge.

Lower Leverage, Less Liquidation (LLLL)

BitMEX is a well-oiled machine and they are very efficient at closing out the riskiest trades. Their risk management protocol comes at the expense of your long-term trading profits.

This is nothing against BitMEX and they are doing exactly what any high leveraged trading operation is doing. They have to make sure that they always have enough funds to cover losing trades.

In fact, BitMEX even has a reserve fund that is used as insurance on those occasions when they cannot stop losing positions fast enough. This insurance fund currently has a balance of 12,336 XBT.

However, if you want to avoid funding the BitMEX insurance fund, don’t trade at 50x or 100x leverage.

The 4 “Ls” will save you in the long run. Lower Leverage -> Less Liquidation

Disclaimer: These are the writer’s opinions and should not be considered investment advice. Readers should do their own research.

Nic is an ex Investment Banker and current crypto enthusiast. When he is not sitting behind six screens trading Bitcoin, he is maintaining his numerous mining rigs. Twitter: @nicrypto