Leverage

When doing leverage, we actually borrow money from the exchange.

A margin account is created and it should be above the initial margin requirement.

If the margin account is below the maintenance margin, the borrower receives a margin call.

Example

I short a future at \$10,000. The initial margin is 20% hence I need $2,000 in my account (= collateral).

Say the future now increases to \$11,000. My margin account is now worth \$1,000 (initial value + unrealized PnL).

Let’s assume the maintenance margin is 10% (calculated on the current value). I thus need \$1,100 in my margin account. Since I am below that level, I receive a margin call. The margin call tells me to either add funds (= “post collateral”) to the margin account or to reduce my short position.

If I don’t do so and the price continues to increase, there will be a liquidation. Note: most exchanges allow a partial liquidation.

Perpetual futures

Perpetual futures are only available in DeFi and not in traditional finance. They have no maturity date and typically allow higher leverage than spot assets.

Perpetual futures have associated funding rate i.e. periodic payments to account for the difference between the underlying price and the contract price.

In traditional finance and when doing leverage, if the trader has a negative balance, the broker would pursue the trader for the debt. But in crypto perpetuals, traders cannot go below zero. To cope with this, an insurance fund steps in to cover the loss. The insurance fund is funded with “successful liquidations” that are liquidations when the exchange liquidated the position before the “official” threshold -> the exchange takes the difference and sends it to the insurance fund. We can thus say that in DeFi, the trader is more penalized if he reaches the maintenance margin because the exchange might take more than what’s actually needed to cover the loss. Additionally, the margin call is not really a “call” in DeFi as the exchange automatically liquidates part or all of the positions once the margin balance falls below the maintenance margin.