After a sudden flash crash, U.S.-based cryptocurrency exchange Poloniex is struggling to deal with the fallout. The situation began when the price of low-liquidity cryptocurrency Clams (CLAM) suddenly entered free fall. The altcoin lost over 66% of its value in a matter of minutes, dropping from over $19 USD a coin to under $6.50. This sudden crash in price triggered a cascading avalanche of stop loss orders. Making matters worse, the low liquidity of the coin prevented all of the stop losses from correctly triggering. This resulted in a loss of 1,800 BTC by the involved traders.
The nature of margin trading allows for substantial losses – losses that the trader is expected to pay back. Poloniex uses a pooled lender system from which margin traders can borrow trading capital. While margin traders are expected to provide some form of collateral, many of those involved in the flash crash liquidation had used CLAM itself as their collateral medium. The sudden reduced value made it impossible to fully recover the losses.
Poloniex and the Legality of Socialized Losses
Grappling with the evaporation of $13.5 million USD, Poloniex decided to ‘socialize’ the loss between all margin lenders. This controversial action also included those that were not active during the loss itself. Poloniex users were understandably upset – particularly those that did not have active loans out at the time.
In a larger problem for Poloniex, the act of socializing losses is not legal in the United States. While margin trading on the exchange is not, theoretically, available for U.S. citizens, that does not mean Poloniex is safe from litigation. Ultimately, the exchange will need to implement greater safety tools to prevent this type of situation in the future.
Margin Trading: The Newest Fad in Cryptocurrency
The news of Poloniex’s disaster comes amidst an explosion in margin trading options in the crypto space. As the cryptocurrency market matures, investors are beginning to expect the same options as traditional financial institutions – margin trading included. Industry leading exchange Binance announced that they would be offering the option to trade on margin ‘soon.’
Given the lax regulations that currently rule the cryptocurrency market, margin trading losses are sure to balloon. Yet, after Poloniex’s recent situation, exchanges seeking to offer margin trading will hopefully take the time to implement safety systems to prevent the complete annihilation caused by flash crashes.
Article By: Adam Stone