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Would really appreciate an ELI5 by someone knowledgeable on whence - as a risk calculation by exchanges - does liquidation come from and if there are (or not)

Would really appreciate an ELI5 by someone knowledgeable on whence - as a risk calculation by exchanges - does liquidation come from and if there are (or not) any mild-leverage alternatives *without* liquidation

TylerE 2y ago
Any leverage exposes you to possible liquidation. That’s what leverage is. You’re essentially borrowing an asset You don’t own to sell.
- deleted 2y ago
  [deleted]
legitster 2y ago
In traditional finance, the brokerage you are working with may notify you and ask for more leverage. Or to warn you if the risk calculation is about to change. It's pretty flexible. This is specifically a crypto problem where everything is automatic and decentralized.
- rrnechmech 2y ago
  Indeed. It is a huge problem IMHO for crypto. (Some outfits are letting you "auto add" margin rather than being liquidated. Not sure if that would help.
pjc50 2y ago
These sorts of trading that isn't buy-and-hold is effectively credit with a variable concluding price. Certainly anything involving leverage is, by definition, credit. Short selling is basically equivalent to put options. Crucially, in both cases, as the price goes up the potential loss increases, theoretically unbounded (!). The loss may be larger than the amount of money originally put down. Thus, there are two options: - provide collateral to the broker to indicate that you are still capable of covering the loss. If the trade goes bad, you pay up or lose the collateral. Similar to a mortgage foreclosure. - have a sufficiently good relationship with the broker that they know you're good for unlimited losses, and are willing to take the risk that you go bankrupt and put that risk on the broker's own balance sheet. Brokers observe that a trade which has gone sufficiently far out of the money isn't coming back, and therefore prefer to liquidate early rather than get into deep losses.
- StanislavPetrov 2y ago
  >Short selling is basically equivalent to put options. Crucially, in both cases, as the price goes up the potential loss increases, theoretically unbounded (!). A put option is the option to sell a stock at a certain price on a certain date. If you are buying put options, your exposure is only the cost of what you paid for those options. If the stock price rises and remains above the strike price of your put options on expiration day, your puts simply expire and become worthless. If you are selling put options your maximum exposure is the difference between the strike price and $0, as the stock cannot fall below $0. This is distinct from short selling where you are essentially borrowing shares and you have to buy them back later at whatever the market price is. That is where your potential loss is theoretically infinite as there is no upper limit to how high the share price can go. The same can be said for selling call options (when you don't own the underlying shares, which is called selling covered calls). When you sell call options, you are essentially selling the right for someone to buy shares at a fixed price on a fixed date. If the shares soar above that price, and you don't own the underlying shares, you are forced to buy those shares at whatever the market price (which theoretically has no upper bound) is and sell them to the option holder at the fixed price of the call.
Sohcahtoa82 2y ago
Leverage is basically the same as margin, which is using stock shares or cryptocurrency (I'll just use "shares" for the remainder of this comment) that you own as collateral for a loan to buy more shares. It's often given as a ratio, like 2X. This means that if you buy $100 worth of shares, you can borrow another $100 worth and own $200 worth. The catch is that if the value of the asset drops, you still need to be able to cover your loan with the asset. So if you bought 1 share for $100, you can leverage it to buy 1 additional share. But it's important to note that the actual cash value of your account is still only $100. If the share price drops to $50, then you will likely face liquidation. Why? Because you're still responsible for the $100 loan. If you get liquidated, you're forced to sell your two shares for $50 each, $100 total. But then you have to pay back the loan, so you end up with $0. The upside, however, is that if the share price went up to $150, you could sell your two shares for $150 each ($300 total), pay back the $100 loan, and end up with $200 net. > and if there are (or not) any mild-leverage alternatives without liquidation The only way to do this is to borrow at a lower ratio. ie, $100 of your own cash, then borrow $20 to buy 0.2 shares. The $100 share price would have to drop to ~$17 before liquidation occurs. For brokers to remain solvent, liquidation must occur if the value of the asset drops below the value of the loan.
- rrnechmech 2y ago
  Nicely broken up, thanks for the time spent. Really appreciate how well explained

TylerE 2y ago

Any leverage exposes you to possible liquidation. That’s what leverage is. You’re essentially borrowing an asset You don’t own to sell.

deleted 2y ago
[deleted]

legitster 2y ago

In traditional finance, the brokerage you are working with may notify you and ask for more leverage. Or to warn you if the risk calculation is about to change. It's pretty flexible. This is specifically a crypto problem where everything is automatic and decentralized.

rrnechmech 2y ago
Indeed. It is a huge problem IMHO for crypto. (Some outfits are letting you "auto add" margin rather than being liquidated. Not sure if that would help.

pjc50 2y ago

These sorts of trading that isn't buy-and-hold is effectively credit with a variable concluding price. Certainly anything involving leverage is, by definition, credit. Short selling is basically equivalent to put options. Crucially, in both cases, as the price goes up the potential loss increases, theoretically unbounded (!). The loss may be larger than the amount of money originally put down. Thus, there are two options: - provide collateral to the broker to indicate that you are still capable of covering the loss. If the trade goes bad, you pay up or lose the collateral. Similar to a mortgage foreclosure. - have a sufficiently good relationship with the broker that they know you're good for unlimited losses, and are willing to take the risk that you go bankrupt and put that risk on the broker's own balance sheet. Brokers observe that a trade which has gone sufficiently far out of the money isn't coming back, and therefore prefer to liquidate early rather than get into deep losses.

StanislavPetrov 2y ago
>Short selling is basically equivalent to put options. Crucially, in both cases, as the price goes up the potential loss increases, theoretically unbounded (!). A put option is the option to sell a stock at a certain price on a certain date. If you are buying put options, your exposure is only the cost of what you paid for those options. If the stock price rises and remains above the strike price of your put options on expiration day, your puts simply expire and become worthless. If you are selling put options your maximum exposure is the difference between the strike price and $0, as the stock cannot fall below $0. This is distinct from short selling where you are essentially borrowing shares and you have to buy them back later at whatever the market price is. That is where your potential loss is theoretically infinite as there is no upper limit to how high the share price can go. The same can be said for selling call options (when you don't own the underlying shares, which is called selling covered calls). When you sell call options, you are essentially selling the right for someone to buy shares at a fixed price on a fixed date. If the shares soar above that price, and you don't own the underlying shares, you are forced to buy those shares at whatever the market price (which theoretically has no upper bound) is and sell them to the option holder at the fixed price of the call.

Sohcahtoa82 2y ago

Leverage is basically the same as margin, which is using stock shares or cryptocurrency (I'll just use "shares" for the remainder of this comment) that you own as collateral for a loan to buy more shares. It's often given as a ratio, like 2X. This means that if you buy $100 worth of shares, you can borrow another $100 worth and own $200 worth. The catch is that if the value of the asset drops, you still need to be able to cover your loan with the asset. So if you bought 1 share for $100, you can leverage it to buy 1 additional share. But it's important to note that the actual cash value of your account is still only $100. If the share price drops to $50, then you will likely face liquidation. Why? Because you're still responsible for the $100 loan. If you get liquidated, you're forced to sell your two shares for $50 each, $100 total. But then you have to pay back the loan, so you end up with $0. The upside, however, is that if the share price went up to $150, you could sell your two shares for $150 each ($300 total), pay back the $100 loan, and end up with $200 net. > and if there are (or not) any mild-leverage alternatives without liquidation The only way to do this is to borrow at a lower ratio. ie, $100 of your own cash, then borrow $20 to buy 0.2 shares. The $100 share price would have to drop to ~$17 before liquidation occurs. For brokers to remain solvent, liquidation must occur if the value of the asset drops below the value of the loan.

rrnechmech 2y ago
Nicely broken up, thanks for the time spent. Really appreciate how well explained