Binance aims to significantly reduce the risks customers can take on a leading cryptocurrency product after a backlash from regulators and consumers over high-risk derivatives that could quickly leave users with painful losses.
The cryptocurrency exchange, which facilitates deals worth hundreds of billions of dollars a month, said it will reduce the maximum leverage — the amount investors can borrow to inflate their bets — on its futures contracts to 20 times from a previous peak of 125. Crypto tycoon Changpeng Zhao, who runs Binance, said the cuts are “in the interest of consumer protection” and will be implemented over the “next few weeks.”
Binance announced its decision on Monday, following a similar move by rival FTX over the weekend. This comes about two months after traders lost an estimated $8.6 billion through liquidations during the May 19 crypto flash crash.
“It is clearly a mistake that a lot of these unregulated crypto platforms give retail investors too many ropes to hang themselves,” said Stephen Kelso, head of markets at brokerage ITI Capital. He said the leverage cut was “an inevitable response to popular anger at taking advantage of retail clients.”
Binance futures are among the most traded products in the trillion dollar crypto derivatives market. The platform, like many of its competitors, allows traders to make huge gains based on small cash stakes. But consumer capital could be wiped out with a slight jolt to the highly volatile cryptocurrency markets.
‘Very big bets’
The UK’s financial watchdog has banned the sale of crypto-derivatives to retail traders over concerns that they are too risky, and regulators around the world have tried to crack down on the unauthorized sale of these products through cryptocurrency platforms. However, offshore exchanges such as Cayman Islands-listed Binance have continued to offer these derivatives, even to residents of jurisdictions where they are banned.
Binance is a leading crypto derivatives firm known as perpetual futures, which tracks the prices of digital currencies ranging from bitcoin and ether to esoteric tokens such as the Dogecoin. The potential returns and risks are magnified by the very high levels of leverage that users can afford.
Anatomy of Cryptocurrency Futures
Perpetual cryptocurrency futures are different from those typically offered in traditional markets, such as those that track oil or wheat prices or stock indices, because they can be held indefinitely.
The expiration date in a traditional futures contract helps to tie the future contract to the price of the underlying asset, since the owner usually receives the asset on that date.
With perpetual futures contracts, the “financing rate” mechanism links the forward rate to the spot rate. When the parties diverge, one party on one side of the trade must pay the other within a specified period every eight hours. These payouts are based on the theoretical size of the trader’s position – which means they can be significant for high-leverage bets.
On Monday, Binance customers could still place future bitcoin trades with leverage of up to 125 times the amount they placed. A user, for example, can put the equivalent of $2,500 on the table to bet $250,000 – 100 times the leverage.
This extends far beyond what customers can do in many traditional markets. In the UK, retail traders’ leverage is limited to 30 times on CFDs – risky bets in the foreign exchange market.
Binance’s platform automatically liquidates clients’ trades when losses on bets exceed investors’ allocated deposits. In highly leveraged trades, this can mean that even a small move in the bitcoin price can drain clients’ money.
“No one simply understands these complex mechanisms unless they are an expert in financial markets and cryptocurrencies, and there are not many around them,” said Carol Alexander, a professor at the University of Sussex who studies the digital asset market. Merchants’ have very little margin [for error] But they’re taking a big bet.”
“The most painful experience I’ve ever had”
Susanna K, a marketing executive from Sydney, Australia, fell into this situation when the cryptocurrency markets collapsed in a two-hour period of extreme volatility on May 19.
Susanna started trading in the growing cryptocurrency markets during the Covid-19 lockdowns of 2020, with the help of friends and information from YouTube videos. “It’s not like I’m a newbie or anything,” she said. It started trading derivatives on Binance a few weeks ago, after generating at least $150,000 in exchange-traded coins in early 2021.
When the price started dropping, Susanna had several hundred thousand dollars in reserve in her bank accounts, which she began to transfer to Binance to prevent her positions from being liquidated. But she said she could not transfer funds fast enough and also struggled to use the systems of Binance, which had technical problems that day.
By the end of the day, it was down more than $250,000. “I was terrified,” she said. “It was the most traumatic experience I’ve had in my life.”
Case Study: “Autofilter” Spiral
Auto-liquidations are one of the main features of leveraged cryptocurrency trading. The higher the level of borrowing, the higher the risk of eliminating the initial capital of the trader.
When a user enters into a trade, Binance sets a “liquidation price” that takes into account factors such as the initial leverage, the funds that support futures trading, and the starting price.
The Financial Times used Binance pricing data and the exchange’s mathematical formulas to build this case study. The trade was entered on February 2, 2021 when Bitcoin was trading at $33,468.
This $2,500 trade was entered with a leverage of 100 times, giving it a “virtual” volume of $250,000. It will only take as low as $32,293 for Binance to clear the bet. This trade could have performed well initially as the bitcoin price surged, maxing out over $180,000 excluding fees and funding costs.
But the sudden crash on May 19 – where the bitcoin price fell from around $38,000 to about $30,000 in less than two hours – quickly left the trader with a choice between closing the position, likely at a loss, or putting in additional capital to keep. Going.
To avoid liquidation, the user had to pay an additional $30 thousand. If they fail to risk losing everything.
Binance also gives users access to a more complex feature called “cross assets” margin, where the liquidation price is also affected by unrealized gains and losses on other trades in addition to the amount deposited in the user’s futures account. This means that when the markets go down in tandem, it can cause a domino effect as each weak bet also increases the odds that other trades will fail as well.
These kinds of spirals, as traders inject ever-increasing amounts of capital in an effort to protect their initial outlay, are one factor that makes leveraged crypto bets so risky.
Many traders who have experienced losses like Susanna have turned to social media platforms like Reddit and Discord, which helped build the popularity of crypto trading, to share stories of their misfortunes. Hundreds of Binance clients from all over the world have formed online groups in order to pursue the exchange in exchange for compensation.
Many of them have had limited success so far and Binance says it will only accept claims when “users experience actual losses due to system issues or errors but not as a result of market volatility.”
The company said that some users who claimed losses had “previously made profits during the bull market”. He said this was “too often a sign that the user was beginning to assume they would always be on a winning streak and ignore the risks inherent in all trading activity.”
Data visualization by Alan Smith
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