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When a leveraged position gets liquidated badly enough, the exchange is left with a loss it cannot recover from the losing trader. That loss has to go somewhere. Without an insurance fund, it goes to the winning side of the trade, to traders who did nothing wrong.
The insurance fund is a reserve held by crypto futures exchanges to absorb exactly that gap. Without it, those losses would fall directly on profitable traders on the other side of the trade.
The insurance fund operates at the exchange level, not the position level. It does not protect a trader from being liquidated. It protects profitable traders on the other side from being forced into auto-deleveraging when a liquidation goes wrong. The fund is a backstop for the market, not for individual positions.
Futures contracts require two sides: a losing position and a winning one. When a losing position gets liquidated and closes at a bad price, the winning counterparty still expects their full profit. The insurance fund sits between that bad liquidation and the profitable trader’s account.
Each perpetual futures exchange maintains its own separate fund. The size varies by exchange and by the specific futures market. It is funded entirely by the exchange’s liquidation process, not by trader deposits.
Every liquidation involves two key price levels. The liquidation price is where the exchange takes over a position. The bankruptcy price is the point where the trader’s margin is entirely gone. The gap between those two prices determines whether the fund gains or loses from each liquidation.
The exchange sets a maintenance margin level for each position. When losses push the margin balance below that level, the exchange initiates liquidation and attempts to close the position in the open market.
In leveraged trading, every profitable trade is backed by a losing one. When a losing position runs past zero, the loser has nothing left to pay. That gap has to be covered by someone.
Without an insurance fund, exchanges pass that loss to profitable traders. Two mechanisms apply: auto-deleveraging (ADL) closes profitable positions early, and socialized loss spreads the shortfall across all winning traders. Either outcome penalizes a trader for being right.
The insurance fund absorbs the gap so profitable traders are not affected. Winning positions stay open and receive full settlement. ADL and socialized loss are unpredictable, which erodes confidence in the exchange over time.
What most traders think: The insurance fund protects losing traders from a bad outcome.
What actually happens: The fund protects winning traders. It exists so profitable positions are not forced closed or reduced to pay for someone else’s failed trade.
A trader’s long gets liquidated worse than the bankruptcy price. Without the fund, the exchange claws back part of the winning short’s profit to cover the gap. With the fund, the short gets paid in full.
When a position is liquidated, the exchange takes it over and tries to close it at the best available market price. The outcome of that closure determines what happens to the fund.
Each liquidation produces one of three outcomes depending on where the exchange can close the position relative to the bankruptcy price.
| Scenario | What Happens at Close | Effect on Fund |
|---|---|---|
| Position closes between liquidation price and bankruptcy price | Exchange recovers more than the minimum needed | Fund gets topped up |
| Position closes exactly at the bankruptcy price | Exchange recovers exactly the minimum needed | No change to fund |
| Position closes worse than the bankruptcy price | Exchange recovers less than the minimum needed | Fund pays the difference |
These scenarios illustrate how the insurance fund balance changes relative to the bankruptcy price. Actual fund impact depends on position size, market depth, and conditions at the time of liquidation.
A trader holds a profitable short as another trader’s long gets forced into crypto futures liquidation during a fast price drop. The exchange cannot close that long at a good price, so it settles worse than the bankruptcy price. The insurance fund pays the gap, and the short trader’s position stays open and unaffected.
When the fund is fully depleted, it can no longer cover liquidation gaps. The exchange has no choice but to activate auto-deleveraging (ADL).
ADL closes profitable positions on the winning side of the market to absorb the loss. These traders did nothing wrong. Their positions get partially closed because the fund ran out of room covering someone else’s failed liquidation.
Liquidation closes losing positions. ADL closes winning ones. That distinction is what makes insurance fund health worth watching when markets move fast.
On March 12, 2020, BitMEX’s insurance fund dropped 1,627 BTC in a single day. That was a 4.58% drawdown, caused by cascading liquidations during the Black Thursday market crash.
BitMEX lost 4.58% of its insurance fund in a single day on March 12, 2020, during the Black Thursday crash. When the fund cannot cover liquidation gaps, ADL fires automatically. Profitable positions on the winning side of the market get partially closed with no warning. A trader who is correct on direction can still lose part of a winning position when ADL activates.
A healthy insurance fund means ADL is unlikely to fire. A fund that runs low means profitable traders face the risk of having winning positions partially closed without warning.
Two conditions create the most stress on a fund: high open interest and sharp, fast price moves. More open contracts mean more potential liquidations. Faster moves mean more of those liquidations settle at prices worse than the bankruptcy price.
The warning signs are visible before a fast crash hits. When open interest climbs sharply and funding rates go very high or very low, the market has more open leveraged positions than usual. That is when a single sharp move can trigger mass liquidations and pull the fund down fast.
A trader with a profitable position in those conditions carries a risk that is not visible on the chart. The size of the insurance fund, and how fast it is moving, determines whether a winning trade stays open or gets partially closed by ADL without warning.
Rising open interest combined with volatile markets increases the number of liquidations and the likelihood that those liquidations close at prices worse than the bankruptcy price. More bad liquidations mean the fund drops faster. A trader with a profitable position should be aware that high-stress market conditions make ADL more likely to fire.
No. The insurance fund does not prevent liquidation. It protects profitable traders on the other side of the market from being forced into auto-deleveraging when a liquidated position closes at a worse price than expected. Liquidation happens regardless of how large or healthy the fund is.
When the fund is depleted, the exchange activates auto-deleveraging (ADL). ADL closes profitable positions on the winning side of the market to cover the shortfall from a bad liquidation. Traders selected for ADL have their positions partially closed with no input from them.
The fund builds from surplus generated by clean liquidations. When a liquidated position closes at a price between the liquidation price and the bankruptcy price, the exchange recovers more than the minimum needed. That surplus gets added to the fund. Over time, a market with mostly clean liquidations grows its fund balance.
Bybit has a public Insurance History page that shows the fund balance over time. On Binance, the path is Futures, then Data, then Futures Data, then Insurance Fund History. Both exchanges update the balance regularly and show historical fund levels.
The insurance fund is the layer between a bad liquidation and a profitable trade on the other side. Every clean liquidation adds to it. Every bad one draws it down. When it runs dry, ADL fires and winning positions pay the price.
Fund health matters most when open interest is high and markets are moving fast. Both conditions increase the number of liquidations and raise the chance that those liquidations settle at prices worse than the bankruptcy price.
Crypto futures traders with profitable positions carry a risk that most charts do not show. ADL can close a winning trade without warning. Understanding how the fund builds, how it depletes, and when auto-deleveraging activates is part of a complete picture of futures risk.
This article is published under Leverage.Trading’s leverage trading & crypto derivatives education , an independent risk-first learning system built to help traders quantify and manage risk before trading.
