"Position 'Evaporation' in Extreme Market Conditions: Understanding the ADL Mechanism Behind Perpetual Futures"

Many traders must have had this experience: waking up to find that the Perptual Futures position they originally held has been automatically liquidated, and the unfamiliar term "Automatic De-leveraging (ADL)" on the account page has become the biggest mystery in their minds. Today, we will break down this "ultimate rule" hidden behind the Perptual Futures market in the simplest way.

To understand ADL, one must first break a cognitive misconception: taking Bitcoin (BTC) Perptual Futures as an example, there are no real Bitcoins in this market. What supports the operation of the entire market is essentially a pool of funds injected by participants, and Perptual Futures are merely a set of rules that allow this cash to simulate "Bitcoin trading."

The core of this set of rules is like the two ends of a balance scale - the positions of the bulls (bullish) and bears (bearish) must be absolutely balanced; otherwise, the entire trading system will collapse in an instant. All traders must deposit margin into a fund pool. When the BTC price fluctuates sharply, funds will be redistributed between the long and short sides: if the price rises, the bulls profit and the bears lose; if the price falls, it is the opposite. Once one side's losses exhaust their margin, they will be forcibly liquidated by the system and completely exit the market.

Here is a key logic: the profits of the long position essentially come from the losses of the short position; the profits of the short position completely depend on the losses of the long position. When one side is liquidated and the funds are reduced to zero, the corresponding other side loses its source of profit, and the system balance is disrupted. At this point, the market will first attempt two ways of "self-rescue":

1. Dependence on market liquidity: By looking for new traders to take over clearing positions through the order book, the margin injected by new entrants can refill the fund pool, restoring balance to the system. In normal market conditions with ample liquidity, this mechanism is efficient and smooth, allowing all parties to exit satisfactorily.

2. Start the insurance fund to provide a safety net: If the order book lacks liquidity, the "insurance fund" set up by the exchange will step in to take over. This special pool of funds can be considered the market's "firefighter," often able to take over liquidation positions at low prices and sell at high prices when the market reverses. In fact, some exchanges' insurance funds have made as much as $40 million in just one hour. However, the insurance fund does not provide an infinite safety net; its funding scale and risk tolerance are also limited.

When both methods fail, ADL - the "last line of defense" in this market will be activated. It is similar to how airlines handle overbooked flights: they first try to attract passengers to voluntarily change their bookings by increasing compensation, and if no one responds, they can only forcibly disembark some passengers. In the Perptual Futures market, when the losing party is liquidated and no one takes over, the system will directly force the profitable party to close their position and exit, in order to restore the long-short balance.

Although the ADL rules of different exchanges vary, the logic of selecting positions for liquidation is highly consistent, prioritizing three types of "big whales": first, the traders with the highest profit amount; second, positions with extremely high leverage; and third, accounts with the largest holdings. In simple terms, the traders who earn the most, gamble the hardest, and have the largest volumes will be the first to be "invited" out of the market by ADL.

Many people complain about ADL – clearly the profit momentum is good, yet the trading is forcibly terminated, which seems very unfair. But from another perspective, the existence of ADL is precisely the "safety valve" of the market. No exchange can guarantee that the losing party's fund pool will never be filled, and the emergence of ADL is to prevent the entire trading system from collapsing due to one-sided market conditions.

In fact, the perpetual futures market is like a zero-sum game of Texas Hold'em: you win all of your opponent's chips at one table and continue to win after switching tables, but when everyone else in the casino runs out of chips, the game cannot continue—ADL essentially means forcibly terminating the games of some winners when the "casino chips are exhausted." There are no real asset price fluctuations here, only the flow of funds among participants, and just like the laws of thermodynamics, the value in the system is neither created out of nothing nor disappears without reason.

Perptual Futures use precise rules to construct a "trading illusion" that is highly similar to the spot market. Most of the time, we can immerse ourselves in this simulated scenario and trade normally. However, when the market conditions become extreme and reach the boundary of the rules, ADL will act like the door to the outside world in "The Truman Show," reminding us that this trading game ultimately has its "rule ceiling." #BTC