In the cryptocurrency perpetual futures market, Auto-Deleveraging (ADL) serves as the ultimate safety mechanism during extreme volatility and liquidity crises. Its core operational logic is as follows:

Market Nature: The perpetual futures market is inherently a zero-sum game. The system consists only of a cash pool, simulating asset price fluctuations through rules, with long and short positions always maintaining balance.

Liquidation Mechanism: When sharp price movements deplete one party's margin, the system forces liquidation. Under normal conditions, liquidations are absorbed by new capital via the order book.

Insurance Fund Intervention: When order book liquidity is insufficient, the exchange's insurance fund steps in to cover losing positions, but its capital is limited.

ADL Activation: If the insurance fund cannot cover the losses, the system forcibly closes profitable positions (typically prioritizing "whales" with high profits, high leverage, and large positions) to restore long-short balance.

Necessity: Although ADL may seem unfair, it is essential for maintaining the system's overall solvency and preventing market collapse due to one side's capital depletion.

This mechanism reveals the virtual nature of perpetual futures markets—when the boundaries of the simulated world are breached, ADL becomes the final defense for system stability.

---

Summary

Author: Doug Colkitt

Compiled by: Deep Tide TechFlow

Given that many have woken up to find their perpetual futures (perps) positions liquidated and are wondering what "Auto-Deleveraging" (ADL) means, here’s a concise primer.

What is ADL? How does it work? Why does it exist?

First, we need to understand perpetual futures markets from a broader perspective. Take the BTC perpetual market as an example—interestingly, no actual BTC exists in this system. The system only holds a pool of idle cash.

What perpetual futures markets (or any derivatives market, broadly) do is redistribute this cash pool among participants. They operate through a set of rules designed to create synthetic instruments that mimic BTC, even though no real BTC is involved.

The most critical rule is: the market has longs and shorts, and their positions must be perfectly balanced; otherwise, the system cannot function. Additionally, both longs and shorts must contribute cash (as margin) to this pool.

This cash pool is continuously redistributed among participants as BTC prices fluctuate.

During this process, when BTC prices swing drastically, some participants lose all their funds and are forcibly exited ("liquidated").

Remember, longs can only profit if shorts have funds to lose (and vice versa). So, when funds are depleted, you can no longer participate in the market.

Moreover, every short must be perfectly matched with a solvent long. If a long in the system has no more funds to lose, by definition, the corresponding short on the other side has no funds to gain (and vice versa).

Thus, if a long is liquidated, one of two things must happen in the system:

A) A new long position enters, bringing fresh capital to replenish the pool;

B) The corresponding short position is closed, rebalancing the system.

Ideally, this is achieved through normal market mechanisms. As long as willing buyers are available at fair market prices, no forced actions are needed. In normal liquidations, this process is typically handled via the perpetual market's order book.

In a healthy, liquid perpetual market, this works seamlessly. Liquidated long positions are sold into the order book, where the best bid becomes the new long, injecting fresh capital into the pool. Everyone is satisfied.

But sometimes, order book liquidity is insufficient, or at least not enough to close the original position without exceeding its remaining funds.

This becomes a problem because it means the cash pool lacks sufficient funds to meet other participants' obligations.

Typically, the next "rescue step" involves an "insurance vault" or "insurance fund" stepping in. The vault, backed by the exchange, is a special cash pool that absorbs the other side of liquidations during extreme liquidity events.

Insurance vaults tend to be highly profitable in the long run, as they can buy at deep discounts and sell at premiums during sharp price movements. For instance, Hyperliquid’s vault earned ~$40 million in about an hour tonight.

But the insurance vault is not magic—it’s just another participant in the system. Like others, it must inject funds into the pool, follow the same rules, and its risk-bearing capacity and capital are limited.

Thus, the system must have a final "rescue step."

This is what we call "Auto-Deleveraging" (ADL). It’s the last resort and (hopefully) a rare occurrence, as it involves forcibly closing someone’s position without paying them out. It happens so infrequently that even experienced perpetual traders often barely notice its existence.

Think of it like an overbooked flight. First, the airline uses market mechanisms to resolve the overbooking, such as increasing compensation to incentivize volunteers to take a later flight. But if no one accepts, certain passengers must be forcibly removed.

If longs are depleted and no one is willing to take their place, the system has no choice but to force at least some shorts to exit and close their positions. Different exchanges have varying processes for selecting which positions to close and at what price.

Typically, ADL systems use a ranking mechanism to select profitable positions for closure based on: 1) highest profits, 2) leverage, and 3) position size. In other words, the largest, most profitable "whales" are sent home first.

Naturally, people resent ADL because it seems unfair. You’re at the peak of your profits, yet forced to exit your position. But to some extent, it’s necessary. No exchange, no matter how robust, can guarantee an infinite supply of losing participants to replenish the cash pool.

Imagine a winning streak in Texas Hold'em. You enter a casino, beat everyone at one table, move to the next and beat them too, and then another. Eventually, everyone else in the casino runs out of chips. That’s the essence of ADL.

The beauty of perpetual futures markets is that they are always zero-sum, so the system as a whole can never be insolvent.

There isn’t even real BTC to depreciate—just a pool of mundane cash. Like the laws of thermodynamics, value in the system is neither created nor destroyed.

ADL is somewhat like the ending of The Truman Show. Perpetual markets construct an elaborate simulation, appearing as a real world tied to spot markets.

But in the end, it’s all virtual. Most of the time, we don’t need to think about it… but sometimes, we hit the boundaries of the simulation.