The primary purpose of the Insurance Fund is to prevent the occurrence of Auto-Deleveraging.
The losses of the Liquidation Engine from the forced closure of the client’s position at a price worse than the Bankruptcy Price are covered from the Insurance Fund. The Insurance Fund is financed by proceeds from the closings of clients’ positions at a price better than the Bankruptcy Price.
ZUBR’s risk-management system is designed to prevent the balance of its clients’ dropping below zero. However, virtual assets are highly volatile and often experience significant price movements. Under certain market conditions, it might be hard to find a counterparty to close the Liquidation Engine position on the market. In that case, the Insurance Fund is reduced by the loss amount of the Liquidation Engine.
In a very unlikely event when the Insurance Fund has depleted the Auto-Deleveraging kicks in.
Below is the example showing the general mechanics of how the liquidation process occurs on ZUBR and how the Insurance Fund kicks in. The graphical explanation is also shown in the chart below.
- The client enters into a long position with leverage > 1x. The position is opened at the current market price. Based on the client’s leverage level, ZUBR’s risk management system calculates the two price levels for this position.
- Bankruptcy Price. If the client closes the position at this price, then the remaining client’s account balance would be exactly zero.
- Liquidation Price. It’s slightly higher (or lower in the case of a short position) than the Bankruptcy Price. That’s the price at which the liquidation is triggered.
- When Mark Price reaches the Liquidation Price level, the liquidation is triggered. In that case, ZUBR makes a dedicated Over The Counter (OTC) trade between the client and the Liquidation Engine account at the Bankruptcy Price. This is an OTC trade which doesn’t go through ZUBR’s order book. Therefore the losing client’s balance after the liquidation will be equal to zero by the design of this transaction.
- After that, the Liquidation Engine starts selling this long position in the market through the order book. Since the Liquidation Engine got this position at the Bankruptcy Price, which is lower (for a long position as per our example) than the Mark Price, there are chances that the Liquidation Engine will be able to close (sell in our example) this position with a profit. Such profit increases the Insurance Fund, which is on average set to grow mathematically over time as the Liquidation Price is always better (i.e. higher for a long position, lower for a short position) than the Bankruptcy Price. In case if the Liquidation Engine sells the position with a loss (i.e. in case of a significant price move), that will result in the Insurance Fund Decrease.
The exact difference between the Liquidation Price and Bankruptcy price depends on the risk limits, which can be here. Liquidation Price is visible for every position in ZUBR’s trading interface.
In more extreme cases, the Liquidation Engine may not be able to close the position. Being highly unlikely it might happen during periods of high volatility or low market liquidity and will trigger the Auto-Deleveraging Process.