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Financial Headlines: Deciphering the Crypto Cascading Liquidation

This article was first published on: 頭條金融報, 星島頭條

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Cascading liquidation is a terrifying reality in the cryptocurrency market that can cause significant financial losses in an instant, such as the March 2019 Bitcoin flash crash and the 2022 stETH de-anchoring event. The mechanism of cascading liquidation is similar to a financial avalanche: some assets are over-leveraged and over-collateralized, with the potential to go from a microwave to a massive wave during a small fluctuation in market prices. As the market price slides, the value of the position falls to the liquidation price; when liquidation occurs, the asset is forced out of the market or auctioned off, further depressing the price and creating a death spiral of liquidation. Cryptocurrencies are particularly susceptible to liquidation chains due to their highly volatile, round-the-clock trading and highly leveraged nature.

A well-built AI system can be an effective deterrent to cascading liquidation. The first defense is AI-driven predictive analytics, which can analyze historical data to generate highly accurate predictive models that anticipate scenarios and triggers that could trigger a liquidation chain, providing traders and the market with early warnings so that market participants have sufficient time to adjust their strategies and positions. Second, AI can simulate multiple market scenarios, including worst-case scenarios, based on current and historical data, to help market participants understand possible contagion effects and develop effective precautions to develop best-practice strategies for managing leveraged positions during periods of high risk. In parallel with the AI prediction mechanism, a negative feedback loop is introduced, which introduces circuit breaker-like trading restrictions when an increase in risk is detected: as the risk level increases, the trading restrictions are progressively increased, making it less attractive for assets to continue to be sold off; if the situation continues to deteriorate, the system may temporarily restrict certain high-risk trades, slowing down the possible contagion and giving the market a chance to stabilize.

With AI's predictive analytics and simulation capabilities, it is possible to identify risks and proactively stop the progress of a cascading liquidation before it threatens, creating a more robust and resilient cryptocurrency market.


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