Liquidation

Liquidation is a multi-step process that is trigged when a trader's account equity is below the maintenance margin requirement. The liquidation process helps prevent negative account equity and maintains market stability.

Liquidation Process

Liquidation occurs over the following steps:

1. Open Market Liquidation

   • Open order cancellation

   • Market close positions

2. Takeover Liquidation and Auto-Deleveraging (ADL)

3. Insurance Fund and Socialized Loss

At each step, if the account equity is now above the maintenance margin requirements, liquidation is complete and the process stops.

Open Market Liquidation

Liquidation begins with forced open-market operations. Here, the liquidatee (subaccount being liquidated) automatically performs market operations to attempt to increase account health.

Open Order Cancellation

First, the system automatically cancels all open orders. This cancellation is crucial as open orders require maintenance margin allocation. By releasing this allocated margin, the account may return to a healthy state without further intervention.

Market Close Positions

Second, if the position remains unhealthy after order cancellation, the system attempts to close positions through market orders. These orders will target prices that leave the account with 70% of the maintenance margin requirement as equity.

For example, if there is an open position for 1 BTC @ 100'000 perpetual with a maintenance margin of 10'000 USDC, market closes will leave at least 7'000 USDC, and so will aggress at a price of 97'000.

Takeover Liquidation and Auto-Deleveraging (ADL)

If open market liquidation is unsuccessful, the protocol enables position takeover through two mechanisms:

Active backstop liquidity providers may takeover all positions, and are compensated by the liquidatee a liquidator_fee percentage of the position's notional. This provides an opportunity for market participants to strategically acquire positions while supporting system stability. Note that the liquidator_fee is expressed as a percentage of the maintenance margin requirement, and is based on the position's initial leverage, where higher leverage positions are charged a greater percentage fee.

If there is insufficient capacity for backstop liquidity, the system implements Auto-Deleveraging (ADL), where traders holding opposing positions automatically assume portions of the liquidated position. The ADL process prioritizes traders based on their PnL ranking.

unrealized PnL = open contracts * (mark price - cost basis)
effective leverage = open contract * mark price / account equity

ranking = if unrealized PnL > 0 {
    unrealized PnL * effective leverage
} else {
    unrealized PnL / effective leverage
}

Position rankings are calculated for open positions and sorted to determine the order of deleveraging.

Insurance Fund and Socialized Loss

Once all positions are closed, any remaining settlement-asset losses are evaluated against the insurance fund. The fund serves as a protective buffer, covering losses to the extent of its available resources.

In cases where the insurance fund is insufficient to cover remaining losses, the protocol implements socialized loss distribution. Losses are allocated across all traders proportionally to their current notional position sizes, ensuring system stability through collective risk sharing.

Liquidation Clearance Fee

To compensate for the risk and operational costs associated with liquidation, there is an additional liquidation clearance fee charged to the liquidatee in the market close and backstop liquidity phases. This liquidation clearance fee is charged on the position's notional value cleared.

The liquidation clearance fee is paid to the insurance fund.

Prices

Liquidation Price

The price for a perpetual contract at which liquidation occurs for the calculated subaccount, supposing that the prices of everything else is constant.

Liquidation occurs when account equity is below the maintenance margin requirement. The constituent changes in the provided contract's price is as follows:

   SUM(spot balance) + SUM(units * price + quote) < SUM(maintenance_margin(units * price))
=> SUM(s_i) + SUM(u_j * p_j + q_j) < SUM(maintenace_margin_j(u_j * p_j))
=> SUM(s_i) + SUM_j!=x(u_j * p_j + q_j) + (u_x * p_x + q_x)
        < SUM_j!=x(maintenace_margin_j(u_j * p_j)) + maintenace_margin_x(u_x * p_x)

   let C1 = SUM(s_i) = spot_balance
   let C2 = SUM_j!=x(u_j * p_j + q_j)
          = unsettled - (u_x * p_x + q_x)
   let C3 = SUM_j!=x(maintenace_margin_j(u_j * p_j))
          = maintenance_margin - maintenance_margin_x(u_x * p_x)
   let K = C3 - C1 - C2

=> C1 + C2 + (u_x * p_x + q_x) < C3 + maintenance_margin_x(u_x * p_x)
=> (u_x * p_x + q_x) - maintenance_margin_x(u_x * p_x) < K
=> (u_x * p_x) - maintenance_margin_x(u_x * p_x) < K - q_x

The left-hand-side is a piecewise continuous function of the contract's price. We can then back out threshold price from the margin table. i.e for a given tier:

   maintence_margin_x(u_x * p_x) = MMR * u_x * p_x - OFFSET
=> (u_x * p_x) - (MMR * ABS(u_x * p_x) - OFFSET) = K - q_x
=> p_x = (K - q_x - OFFSET) / (1 - MMR * SIGN(u_x)) / u_x

Bankruptcy Price

The price at which the account is bankrupt, supposing that the prices of everything else is constant.

   SUM(spot balance) + SUM(units * price + quote) < 0
=> C1 + C2 + (u_x * p_x + q_x) < 0
=> p_x < -(C1 + C2 + q_x) / u_x