High leverage exit in progress

This article is an original piece by Chain Catcher, authored by Richard Lee.

In the absence of regulation and amidst vicious competition, crypto derivatives exchanges have raised leverage from 20x to 100x, 125x, and even 150x. While they profit immensely from this, it is not beneficial for the health of the crypto market or the financial safety of investors. Recently, this situation has seen a turning point.

High leverage seems to be retreating in the crypto market.

On July 25, FTX founder SBF announced on Twitter that FTX would cancel high-leverage products and limit leverage to 20x. The next day, Binance founder Changpeng Zhao also stated on Twitter that Binance's futures contracts would adjust the maximum leverage for new users to 20x, and this cap would also apply to all users in the coming weeks.

SBF stated on Twitter that liquidation trades accounted for less than one percent of FTX's trading volume, and that liquidations on FTX were not the main cause of volatility. However, he acknowledged that high leverage (>20x) is unhealthy and not an essential part of the crypto ecosystem, emphasizing that "everything has its limits."

The industry generally believes that the moves by the two leading cryptocurrency exchanges are in response to increasingly stringent regulatory pressures.

Currently, leading derivatives exchanges such as Binance, FTX, and Huobi have all taken measures to lower leverage, which may lead to some user loss. However, for the crypto market, these measures release a more responsible and compliant positive signal, which is beneficial for the healthy and orderly development of the crypto market.

1. How was leverage "raised"?

For a long time, cryptocurrency exchanges have existed in a regulatory gray area, with strong market speculation tendencies. This has led many exchanges to focus on futures trading as a key product, continuously attracting users and expanding trading volume with high leverage in a vicious competition, rising from the early 20x to the current maximum of 150x.

In May 2016, the derivatives exchange BitMEX announced the launch of a Bitcoin perpetual contract with 100x leverage, marking the first time leverage in the crypto space was raised to such a level. BitMEX remained the exchange with the highest trading volume in crypto derivatives for many years.

"Some people offer similar types of products, focusing on fallen gamblers, namely retail traders of Bitcoin," said BitMEX founder Arthur Hayes. "So why shouldn't we do the same?"

In December 2018, OKEx announced the launch of BTC perpetual contracts supporting up to 100x leverage. As its contract products gained significant traffic and profits, FTX, Binance, and Huobi followed suit.

In April 2019, FTX officially launched, symbolically raising the maximum leverage to 101x, becoming the exchange with the highest leverage in the industry at that time. Subsequent listings of BTC, ETH, HT, and other cryptocurrencies all supported this leverage.

In October 2019, Binance's futures platform announced that BTC futures contracts would support a maximum leverage of 125x, further raising the industry's leverage ceiling.

In response to external skepticism at the time, Binance CEO Changpeng Zhao tweeted, "Not every feature is designed for the general public. Some features may not be liked by everyone, but there is a high demand for specific groups. If you don't like or need it, please don't use it. As a platform, we must remain competitive by providing choices."

Huobi and OKEx quickly followed suit. In March 2020, Huobi announced the launch of perpetual contracts supporting up to 125x leverage. In September 2020, OKEx announced that all contract products would support a maximum leverage of 125x for BTC and 75x for other cryptocurrencies.

Additionally, some second- and third-tier exchanges even pushed leverage to 150x. In June 2020, the derivatives exchange Blade, backed by Coinbase, announced that its contract products could reach 150x leverage. In February this year, BitWell also announced the launch of perpetual contracts with a maximum leverage of 150x.

As leverage in the crypto market continues to rise, significant market fluctuations can easily trigger a chain liquidation of long or short contracts, leading to larger-scale declines in the market, thus amplifying the volatility of the crypto market. In the market crash on March 12, 2020, and the one on May 19 this year, the excessively high market leverage was considered one of the main reasons for the drastic declines.

"On March 12, when the price of Bitcoin plummeted from $7,900 to $3,600 (a drop of over 50%), $1 billion worth of long contracts were liquidated on BitMEX alone," crypto analyst Joseph Young recalled the March 12 crash. "The real problem occurred when the price of Bitcoin fell below $5,000. The severity of this price drop nearly cleared BitMEX's order book."

Ari Paul, managing partner at BlockTower Capital, also noted that when Bitcoin's price fell below $4,800, investors did not choose to sell. The selling pressure mainly came from BitMEX and large liquidations, which then turned into sell orders.

Thus, excessively high leverage is considered one of the biggest systemic risks in the crypto market, leading to criticisms of market manipulation, excessive volatility, and inadequate protection of investor interests, which have affected the further acceptance of cryptocurrencies by traditional financial markets.

"I'm not saying this will lead to the next financial crisis," said Timothy Massad, former chairman of the U.S. Commodity Futures Trading Commission, to The New York Times. "But could it be the butterfly flapping its wings in Brazil that causes a tornado in Texas?"

2. Dual Pressure from Public Opinion and Regulation

In recent years, victims of high leverage in derivatives trading have been frequently reported.

On June 5, 2019, Hui Yi, founder of the crypto market analysis firm Bitwise, committed suicide. Just days before his death, he revealed in a WeChat group that he had opened a short position with 100x leverage using 10 BTC. Prior to that, he had shorted with 20x leverage and 600 BTC. After the market rose, rumors circulated that he chose to end his life due to the unbearable liquidation from 100x leverage. Although the cause of death is disputed, friends stated that the massive losses from the liquidation might have been "the last straw that broke the camel's back."

In recent years, news of retail investors suffering huge losses due to liquidation has frequently appeared in social news, such as "Couple loses 20 million in Bitcoin trading, kills daughter and jumps into the sea to commit suicide" and "Protesters in front of Huobi's building in Hainan are numerous."

In the market crash on May 19 this year, the total liquidation amount across major exchanges exceeded 40 billion yuan. Due to the immense harm caused by high leverage to investors, financial regulatory authorities in many countries have adopted a high-pressure stance against crypto derivatives. However, due to the difficulty of regulating cryptocurrency exchanges, various high-leverage derivatives have continued to operate in gray areas across countries.

As the crypto market has risen this year, more and more new users have entered the market, prompting regulatory agencies in various countries to further strengthen their regulatory attitudes and mechanisms towards the crypto market, and criticism from the main public opinion has also been rising.

First, on May 19, the Financial Stability Development Committee of the State Council issued a notice demanding a crackdown on Bitcoin mining and trading activities, "resolutely preventing individual risks from spreading to the social field." Subsequently, several media outlets published commentary articles and investigative reports on this.

On May 24, the Economic Reference Daily, a subsidiary of Xinhua News Agency, published an article titled "Rectifying the Chaos of Virtual Currency Speculation is Urgent," which mentioned that "many investors attempt to get rich overnight, often amplifying trading leverage to 5 times or even higher, posing huge risks for investors in the case of significant price fluctuations."

On May 29, Xinhua News Agency published an article titled "100x Leverage: Does the Crazy 'Coin Circle' Bring 'Wealth' or 'Liquidation'?" which mentioned several cases of investors facing liquidation after engaging in leveraged trading, pointing out that under high leverage, many investors ended up empty-handed while virtual currency trading platforms profited.

As a result of the aforementioned events, many domestic crypto derivatives trading platforms began to strictly limit the user groups for leverage products and the maximum leverage rates.

On May 25, Huobi announced that to protect investors' interests, it would suspend the opening of futures contracts, leverage, and exchange-traded products (ETP) services for new users in mainland China. At the same time, the maximum leverage for many existing users was also reduced to 5x.

On the same day, the leading derivatives exchange Bybit announced that it would restrict mainland IP users from accessing the API interface. Additionally, crypto derivatives exchanges XMEX, BBX, and others subsequently announced their cessation of operations.

Entering June, regulatory authorities in nearly ten countries, including Japan, the UK, Italy, and Thailand, issued warnings regarding Binance's provision of derivatives trading services without permission. Against this backdrop, leading derivatives exchanges Binance and FTX decided to lower leverage rates, making certain compromises in response to regulatory authorities and external criticisms.

Although regulatory scrutiny of the crypto market has entered a deep-water zone globally, due to the unregulated nature of the crypto market, these regulatory warnings and crackdowns may only have a practical effect on exchanges like FTX and Binance that aim for compliance, while many other exchanges remain outside of regulation and take little action, such as OKEx, Bybit, and MXEC, which still support contract leverage of up to 100x or even 125x.

Leveraged contracts are an important component of any mature financial market, but excessively high leverage is not. How to balance user demand, platform interests, and social responsibility will be a long-term proposition that crypto derivatives trading platforms need to face.