Contract Loss Mechanisms
During periods of high volatility in the markets underlying the perpetual contracts, the value of some accounts may drop below zero before they can be liquidated.
An insurance fund could be the first backstop to maintaining the solvency of the system when an account has a negative balance if put in place by an applicable governance community. The account will be liquidated, and the insurance fund will take on the loss. This insurance fund will be used before any deleveraging occurs.
If an insurance fund is put in place by an applicable governance community and the insurance fund becomes depleted, positions with the most profit and leverage may be used to offset negative-balance accounts in order to maintain the stability of the system.
As part of the default settings of the v4 open source software (”dYdX Chain”), deleveraging is a feature made available by the perpetual contract software. Deleveraging is used as a last resort to close underwater positions if the insurance fund is depleted. Deleveraging works similarly to “auto-deleveraging” in other high-leverage futures and perpetual markets, and is a mechanism which requires profitable traders to contribute part of their profits to offset underwater accounts.
Deleveraging will only be used if an applicable governance community’s insurance fund is depleted.
Deleveraging is performed by automatically reducing the positions of some traders —prioritizing accounts with a combination of high profit and high leverage — and using their profits to offset underwater accounts.
Deleveraging is incorporated in the software (instead of relying on a socialized loss mechanism) to reduce the uncertainty faced by traders trading at lower risk levels.
The most highly leveraged offsetting accounts will be deleveraged first.
Disclaimer and Terms