Insurance Fund

What Is the Insurance Fund?

The insurance fund is a risk management reserve used to cover losses from forced liquidations in extreme market conditions. Its primary goal is to reduce the likelihood of Auto-Deleveraging (ADL), thereby protecting users from involuntary position reductions.

How Are Insurance Funds Generated?

Insurance funds grow through profits realized by the liquidation engine.

Process:

1. When a position is liquidated, the liquidation engine takes over the user's position and remaining margin at the bankruptcy price.

2. If the liquidation engine can close the position at a better price than the bankruptcy price:

   • A profit is generated.

   • This profit is injected into the insurance fund.

$$\text{Profit} = (\text{Exit Price} - \text{Bankruptcy Price}) \times \text{Position Size}$$

These accumulated profits serve as a buffer for future liquidation losses.

How Are Insurance Funds Used?

During liquidation:

1. The liquidation engine assumes the position at the bankruptcy price.

2. If the position cannot be closed without loss, the insurance fund compensates the difference between the actual closing price and the bankruptcy price.

3. This compensation:

   • Reduces the loss from liquidation.

   • Helps avoid triggering Auto-Deleveraging (ADL).

4. If the loss exceeds the insurance fund's coverage, and no counterparties are available to absorb the loss, ADL is triggered.

Shared Fund Across Contracts

All perpetual contracts that use the same margin currency (e.g., USDT) share a single insurance fund. This improves capital efficiency and provides broader protection across multiple markets.

Example:

• A trader's BTC/USDT long position is liquidated.

• The bankruptcy price is $28,000.

• The liquidation engine closes the position at $28,200.

• The $200 profit per BTC (after costs) is added to the insurance fund.

• In a future event, if a liquidation results in a closing price below the bankruptcy price, the fund absorbs the loss, reducing ADL risk for all users.