Insurance Fund

The insurance fund is a key part of any Decentralize ecosystem that allows leveraged trading. It plays a large role in cryptocurrency derivatives exchanges, both centralized and decentralized. The role of such a fund is to ensure a smooth trading experience, even when markets are illiquid or experiencing extreme volatility.

There are three important figures to keep in mind to understand why leveraged trading requires an insurance fund: The liquidation price, the bankruptcy price and the closing price. In a healthy market, with many buyers and sellers, and low slippage, A position will be partially liquidated before it passes its “bankruptcy” price, and the position will be partially sold below its liquidation price, but above its bankruptcy price.

(Partial liquidation prevents a user’s position from suddenly getting liquidated by selling an amount of the position, after the partial liquidation, the user can decide whether to keep the position or not). The insurance fund receives the difference between the closing price and the bankruptcy price.

The insurance fund grows by = Closing price - Bankruptcy price The insurance fund gains capital on liquidated longs when closing price > bankruptcy price. The opposite holds true for liquidated shorts. In illiquid or volatile markets, a position could be sold below its bankruptcy price. In this case, the insurance fund loses money in order to pay the counterparty winning.

trader. The “spread” is the difference between the lowest sell order and the highest buy order. The insurance fund loses capital on liquidated longs when the closing price < bankruptcy price. The opposite holds true for liquidated shorts. In short, capitalizing on the insurance fund is a shared cost for all traders who experience liquidations. In return, traders have the peace of mind knowing that they will always be able to receive their deserved profits.

The Insurance Fund keeps a certain amount in reserve to pay the “spread” in case of losses. When the Insurance Fund’s balance passes the reserve, it will use the residual amount to buy back and burn EVAMETA tokens. The reserve amount which would be held by the Insurance Fund can be voted for by the community and can change over time.