The Risk Mechanism of Perpetual Futures and the Security Assurance of the exchange

Perptual Futures, as a complex financial derivative, are characterized by high leverage and high risk. In order to maintain market stability and fairness, the exchange has established a comprehensive risk management system. This article will delve into the core components of this system, including the margin system, forced liquidation mechanism, risk protection fund, and automatic position reduction mechanism (ADL), among others.

Perptual Futures Risk Management Framework

The risk management framework for Perptual Futures mainly includes three levels:

1. Forced Liquidation: When the user's margin is insufficient, it automatically triggers liquidation, which is the most basic risk control measure.

2. Risk Assurance Fund: Used to compensate for the losses caused by forced liquidation, serving as a buffer against systemic risk.

3. Automatic liquidation mechanism ( ADL ): In extreme cases, positions of profitable parties are forcibly liquidated to cover losses, serving as the last line of defense.

These three mechanisms form a "waterfall" risk management chain, progressing layer by layer, together building a safety barrier for the Perptual Futures market.

Margin and Leverage

Margin is the basis of Perptual Futures trading, divided into initial margin and maintenance margin:

• Initial Margin: The minimum margin required to open a position, which determines the maximum available leverage.
• Maintenance Margin: The minimum margin required to maintain a position; falling below this value will trigger liquidation.

exchanges usually offer various models such as isolated margin, cross margin, and composite margin to meet the needs of users with different risk preferences.

To prevent a single large position from impacting the market, the exchange has also implemented a tiered margin system. As the position size increases, the required margin ratio gradually rises, and the maximum available leverage correspondingly decreases.

Forced Liquidation Mechanism

Forced liquidation is the first line of defense for the exchange's risk control. When a user's margin ratio falls below the maintenance margin ratio, the system will automatically trigger the forced liquidation process:

1. Cancel unfilled orders
2. Take partial profit or implement a tiered liquidation for large positions.
3. Close all positions at market price until the risk is eliminated.

Forced liquidation uses the mark price as the trigger basis, rather than the latest transaction price, to avoid unnecessary liquidations caused by short-term price fluctuations. The range between the forced liquidation price and the bankruptcy price is the operational space of the exchange's risk control system.

Forced liquidation will incur additional clearing fees, which incentivizes users to actively manage risks while providing a funding source for the risk protection fund.

Risk Protection Fund

The risk assurance fund is an important tool for the exchange to cope with systemic risks, mainly used to compensate for the loss caused by forced liquidation. Its sources of funds include:

• Liquidation Fee
• The portion of liquidation surplus ( that has an actual closing price better than the bankruptcy price )

Most mainstream exchanges have established risk protection funds and regularly disclose their size to enhance market confidence. The adequacy of the fund size is directly related to the exchange's ability to withstand risks.

Automatic Deleveraging Mechanism ( ADL )

ADL is the last line of defense in the exchange's risk control, and it will only be triggered in extreme situations when the risk protection fund has been exhausted. Its core logic is:

• Sort the reverse position holders according to the formula "Profit Percentage × Effective Leverage"
• Start from the highest ranking and forcefully liquidate part or all of their positions.
• Settle at the liquidation price of the position that triggered the ADL.

Exchanges usually provide ADL risk indicators to help users understand the possibility of being executed under ADL. Users can reduce ADL risk by lowering leverage, partially taking profits, and other methods.

Conclusion

The risk management system of Perptual Futures is a multi-layered, interrelated complex system. It protects individual traders while maintaining the stability of the entire market. However, no matter how perfect the system design is, it cannot completely eliminate risk. As traders, we must always maintain risk awareness, use leverage judiciously, and actively manage our position risks. Only in this way can we stand undefeated in this market full of opportunities and challenges.