One of the risks that investors are least aware of in cryptocurrency derivative markets is that a profitable position may be forced to be closed by the stock market. This situation is not limited to a technical malfunction or a normal liquidation process. ADL, the automatic debt reduction system used by exchanges, comes into play to ensure the platform’s survival during extreme volatility and can sometimes target the most profitable transactions.
How does ADL work?
In perpetual futures contracts, there must be a seller for every buyer. In transactions opened with high leverage, when the market goes in the opposite direction sharply and the collateral level falls below the maintenance margin, the automatic liquidation system operates. Under normal circumstances, the exchange tries to prevent the deficit by closing the loss position in the order book.
However, in sudden collapses, the simultaneous liquidation of thousands of leveraged accounts can empty the order book in a short time. When liquidity providers withdraw, transactions can shift beyond the bankruptcy price. At this stage, the loss exceeds the collateral deposited by the investor. If the insurance fund maintained by stock exchanges to cover such deficits is insufficient, ADL steps in.
ADL selects positions that are on the opposite side of open harmful contracts and makes high profits and closes them forcefully. Thus, the platform aims to balance the system-wide deficit. In other words, the risk created by loss-making accounts is limited by early closure of profitable accounts.
Mini dictionary: ADL is an automatic debt reduction mechanism. In extraordinary cases where the liquidated losses cannot be covered by the insurance fund, the exchange queues up the profitable positions on the counterparty and closes them compulsorily.
ADL often targets accounts with the highest profits and highest effective leverage to limit the system’s risk of bankruptcy, not the accounts in loss.
Why do stock exchanges use this method?
In traditional financial markets, clearing houses work with bank-backed capital structures and lines of credit. Cryptocurrency exchanges, on the other hand, operate on global markets that are open around the clock and offer high leverage that extends to retail investors. This structure necessitates its own internal security layers without a central recovery mechanism in case of harsh market movements.
For this reason, exchanges prioritize the platform’s solvency and transaction continuity before protecting the individual investor’s maximum profit. Otherwise, irrecoverable losses may grow, withdrawal requests may be disrupted, and a crisis of confidence may arise.
Who is affected first?
Exchanges do not randomly select accounts during ADL. Generally, a real-time ranking is created based on criteria such as unrealized profit ratio, effective leverage, position size and margin ratio. Accounts at the top of the list, that is, investors who both carry high profits and use high leverage, can be ranked first.
| criterion | What does it mean? |
| unrealized profit rate | The return generated by the position according to the initial margin |
| Effective leverage | Ratio of open position size to supporting collateral |
| Position size | Total volume of open contracts |
| Margin rate | Relationship between account balance and required maintenance coverage |
The risk increases especially when there is one-way concentration in the market. If there is a sudden price break in an altcoin transaction where most of the participants are positioned on the same side, there may not be enough natural buyers or sellers on the other side. This picture develops much faster in low depth markets.
A stop loss order placed by the exchange does not provide protection against the ADL; because one is the investor’s own order and the other is the mandatory risk protocol that the platform directly implements.
How investors reduce risk
The idea that risk ends when high profits occur can be misleading in derivative markets. Although investors monitor the downside risk, they often ignore the upside risk arising from the system. The difference between isolated margin and cross margin also becomes important here. Although cross margining can reduce ordinary liquidation risk, it can also expose the entire account balance to a broader systemic impact in case of sharp market movements.
In order to reduce the risk, lowering the leverage level, placing additional collateral on profitable positions, closing a part of the position and monitoring the ADL risk indicators offered by the stock exchanges come to the fore. Not keeping the capital on a single platform can also limit the impact of a possible insurance fund pressure on the entire portfolio.
