Comment by dcolkitt
3 years ago
> Crypto has tried to solve this by strict liquidation rules that tend to make things worse by turning firms into forced sellers
This is literally how traditional finance works as well. If you have a leveraged position at a futures or options exchange, you absolutely will be liquidated as soon as your position gets close to being in the red. I 100% guarantee you that the CME or Goldman will not let you "ride things out".
You don't have to take my word for this. Look up the history of what happened to the energy hedge fund Amaranth.
Individual investors tend to get liquidated, but for hedge funds larger investors the story is more complex. See <https://www.bloomberg.com/opinion/articles/2021-07-29/archeg...>:
> In the traditional financial system, very few things work like this. One thing that mostly does is a margin account at a retail stock brokerage: If your stock declines, you will get a margin call, and if you don’t post margin within a defined and fairly tight time frame your broker will sell the stock, and this really might all be done by a computer in a pretty formulaic way. But if you have a big enough account — if you are a big hedge fund or family office — it doesn’t work that way. When Credit Suisse Group AG decided that Archegos Capital Management did not have enough collateral in its margin account, a Credit Suisse representative called Archegos and asked it to post more collateral, and Archegos said, sorry, we are really busy this week, let’s discuss next week. In theory Credit Suisse could have liquidated Archegos’s positions, but in practice that would have been rude, so it didn’t. Credit Suisse did not extend credit to Archegos based on some defined formulaic function of the value of its collateral; Credit Suisse extended credit to Archegos based on some fuzzy holistic relationship-based function of how much business it hoped to do with Archegos, how much the Credit Suisse people liked the Archegos people, how its traders felt about the collateral, when its risk committees had meetings, stuff like that.
Credit Suisse may thought it was rude, may have been thinking about maintaining the relationship long term or may have suspected liquidating the assets would net it less than what was owed with no recourse for the other part.
In the meantime, Goldman went ahead and liquidated Archego's position.
That old saw is evergreen: If you owe the bank $100, that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.
Not really true, collateral is decided at the end of the day and not mid day.
You aren't liquidated immediately the moment your needs more liquidity.
We wait till the end of the day short of absolute emergencies.
I know Amaranth well being in Canada and Calgary specifically at the time:)
And for tradfi a typical hedge fund gets a call and is told to post more collateral and they make real efforts to allow the fund to post collateral. There is almost never an immediate liquidation as this tends to cause more trouble than it fixes, even on the CME or CBOE:)
>Not really true, collateral is decided at the end of the day and not mid day.
Ho ho ho - no it's decided as soon as your lender things that it needs to liquidate you, and if it does it will know that you're not going to be able to go to court to fight afterwards.
A lot of nasty scenes start with someone on a phone shouting "you can't do that for another 2 hours".
Yup. Yup we can.
You write this comment as if you regularly liquidate people. Is this something you've done a lot?
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Especially when one of the main reasons for needing to post more collateral isn't necessarily that your position is underwater but rather volatility has picked up and risk needs to be brought down. This happens because futures especially trade with very high leverage.
Also generally the amount of collateral that needs to be posted is in the millions of USD so people tend to understand that isn't instant, especially if those funds are currently in money market funds or bonds held elsewhere.
>> Not really true, collateral is decided at the end of the day and not mid day.
Depends on your CSA (Credit Service Annex/Agreement) and what the joint agreement was. Also depends on the type of position (daily settled via exchange vs contractual)
> You don't have to take my word for this. Look up the history of what happened to the energy hedge fund Amaranth.
Amaranths positions were sold to Citadel and JP to wind down gently. That's pretty different from forced liquidation at the exchange.
CME, the exchange, is not the one closing on you.
Your prime brokerage is.
https://www.investopedia.com/terms/p/primebrokerage.asp
Of course, crypto didn't invent margin trading. I think the OP was referring to central counterparty clearing, which typically provides an additional layer of insurance against defaults.
As per Matt Levine:
...The way the traditional system works is that if you have a margin loan, and the value of your collateral declines, your broker calls you up and says “hey we need more collateral,” and you either post more collateral and it’s fine, or you don’t post more collateral and your broker liquidates your position. Or sometimes you say something like “hang on I’ve got another call, I’ll call you back after lunch,” or “sorry I don’t have the money right now but I am a good customer and you know I’m good for it,” or “I don’t have the money right now but I’m pretty sure prices can only recover from here so why don’t you let it ride for a day or two,” or whatever, and you don’t post more collateral but your broker doesn’t liquidate your position because you’re a human and your broker is a human and everyone is embedded in a repeated social game with fuzzy rules
For every seller, there must be a buyer. With a defi "code is law" approach, if every contract automatically tries to execute a sell at the same time, the price will fall until there are enough matching buyers, and if there still aren't enough buyers when BTC hits $0.0000001 then the sell orders will just not execute. Smart contracts do not eliminate the problem of liquidity risk, they merely assume it away.
Yes. It seems not appreciated by some that price need not move continuously, but it can jump, and it can also go to zero (or if it cannot: no buyer can be found at the smallest possible positive price).
>> This is literally how traditional finance works as well.
Most recent case is that Archegos guy over-leveraged at Credit Suisse not to mention the LME or GME fiasco. The "traditional" market is rigged/bended by various individuals ALL THE TIME.
https://www.reuters.com/markets/commodities/elliott-associat...
>> I 100% guarantee you that the CME or Goldman will not let you "ride things out".
That is indeed generally the case. There are, however, monthly collateral agreements in some cases where you can ride it out for a month before getting margin called. Also, there are sometimes credit-rating based collateral calls. The most famous would be AIG's -- they eventually had margin calls of over $100B when their credit rating fell and the housing market also fell and liquidity dried up.
Funny thing in such cases -- when the borrower owes banks those sums of money, it ceases to be the borrower's issue and becomes the bank's issue