Liquidation, Leverage and Optimal Margin in Bitcoin Futures Markets

TL;DR

This paper analyzes liquidation risks, leverage, and optimal margin requirements in Bitcoin futures markets using extreme value theory, revealing high liquidation rates and proposing increased margin requirements to mitigate risks.

Contribution

It introduces a novel application of extreme value theory to determine optimal margins and liquidation risks in Bitcoin futures, challenging normality assumptions.

Findings

Daily forced liquidations are substantial at 3.51%.

Average leverage of 60X among liquidated traders.

Proposed margin increases to 33% for longs and 20% for shorts.

Abstract

Using the generalized extreme value theory to characterize tail distributions, we address liquidation, leverage, and optimal margins for bitcoin long and short futures positions. The empirical analysis of perpetual bitcoin futures on BitMEX shows that (1) daily forced liquidations to out- standing futures are substantial at 3.51%, and 1.89% for long and short; (2) investors got forced liquidation do trade aggressively with average leverage of 60X; and (3) exchanges should elevate current 1% margin requirement to 33% (3X leverage) for long and 20% (5X leverage) for short to reduce the daily margin call probability to 1%. Our results further suggest normality assumption on return significantly underestimates optimal margins. Policy implications are also discussed.