The Risk Protection Fund (Insurance Fund) is a crucial mechanism in derivatives trading platforms. It is designed to cover losses caused by forced liquidations, ensuring fair trading while maintaining market liquidity and reducing the risk of Auto-Deleveraging (ADL).
Core Functions of the Risk Protection Fund
- Covering Liquidation Losses: When a position is forcibly liquidated in a highly volatile market but lacks sufficient liquidity, causing the final execution price to be lower than the bankruptcy price, the Risk Protection Fund will cover the loss.
- Ensuring Profit Payouts: The fund helps ensure that profitable traders receive their earnings without disruptions caused by liquidity shortages.
- Reducing Auto-Deleveraging (ADL): A sufficient fund balance can absorb losses, reducing the frequency of ADL triggers and preventing profitable traders from being forced out of the market.
How the Risk Protection Fund Works
🔹 Accumulation Mechanism:
- When a liquidated position is executed at a price better than the bankruptcy price, the remaining margin is added to the Insurance Fund to cover future potential losses.
- For example, if a trader’s bankruptcy price is 39,950 USDT, but the final liquidation price is 39,980 USDT, the extra 30 USDT is credited to the fund.
🔹 Compensation Mechanism:
- If a liquidated position is executed at a price worse than the bankruptcy price, the Insurance Fund will cover the difference to prevent negative market impact.
- For example, if a trader’s bankruptcy price is 39,950 USDT, but the final execution price is 39,930 USDT, the fund covers the 20 USDT loss.
🔹 Auto-Deleveraging (ADL) Mechanism:
- If the fund is insufficient to cover liquidation losses, the ADL system is triggered, spreading the loss across other traders.
- ADL prioritizes reducing positions of highly leveraged and highly profitable traders to balance market risks.
Example: BTC/USDT Long Position Liquidation
Assume a trader holds a long position in BTC/USDT with:
- Liquidation Price: 40,000 USDT
- Bankruptcy Price: 39,950 USDT
📌 Scenario 1: Surplus Added to the Fund
- If the position is liquidated at 39,980 USDT, the extra 30 USDT (39,980 - 39,950) is transferred to the Insurance Fund.
📌 Scenario 2: Fund Covers Losses
- If the final execution price is 39,930 USDT, the fund absorbs the 20 USDT (39,950 - 39,930) loss.
📌 Scenario 3: Fund Deficit Triggers ADL
- If the fund lacks sufficient balance, the ADL system will be activated, forcing profitable and highly leveraged traders to reduce positions to cover losses.
Conclusion
The Risk Protection Fund is vital for contract trading, preventing liquidation losses, reducing ADL occurrences, and ensuring fair profit distribution. Its key functions include:
✅ Accumulating funds from profitable liquidations
✅ Covering losses from forced liquidations
✅ Triggering ADL only when necessary
This mechanism ensures market stability and a fair trading environment for all participants.
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