Have you ever wondered how cryptocurrency exchange platforms are able to handle heavy trading volumes along with periods of strong volatility? A good way to understand how these exchanges are able to stay afloat is to look at their derivative operations. Exchange platforms are only as good as their market-making operations are managed, and this means providing an assurance to traders that their positions will be safe even during extremely volatile trading sessions.
In the case of BitMEX, one of the strategies consists of operating an insurance fund, which is a must when dealing with investment assets that can gain or lose 10% of their values in just one hour. Insurance funds are essentially derivative products, and they are managed for the purpose of handling the risk of margin trading. Similar to markets where equity securities, futures, and options are traded, positions held in cryptocurrency pairs can be liquidated by means of margin calls once they reach a certain loss level. Margin calls can be avoided with stop loss features, but not all Bitcoin traders take advantage of them.
What exchange platforms such as BitMEX try to do through insurance fund operations is to fall into situations whereby positions are left in a bankrupt status. In essence, the fund takes the opposite side of a losing trade to come out even or at least to mitigate the loss. These are profitable trades, but not by much; the idea is to collect enough gains to offset volatility.
Bitcoin traders may feel safer by knowing that their exchanges operate derivative markets in order to avoid a trading catastrophe, but this does not let them off the hook in terms of margin calls. Whenever a trade requires leverage, the risk increases exponentially; for this reason, it is better to avoid leverage in the first place. Even better, traders should only invest what they can reasonably afford to lose without experiencing financial hardship, but this is not always the case. Respected cryptocurrency exchanges will estimate what liquidation prices will be for every position that requires leverage; it is up to traders to look up these prices and activate stop loss features.