Perpetuity Documentation

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Auto Deleveraging ​

Why Auto-Deleveraging is Essential ​

Auto-deleveraging is a critical risk management mechanism for exchanges, particularly those offering leveraged trading. It serves as a last-resort safety net when the insurance fund is severely depleted or the community fund is overleveraged. The primary purpose of ADL is to maintain the solvency of the exchange and protect the protocol from systemic risk. Without ADL, exchanges could face catastrophic failure during extreme market conditions where liquidations cannot be processed normally.

How Rare ADL Is ​

ADL is an extremely rare event that only occurs in extreme market conditions. In Perpetuity's implementation, it's triggered only when:

  • The insurance fund is severely depleted (below 50% of minimum)
  • The community fund for a specific market is overleveraged (exceeding 3x)

These conditions typically only occur during:

  • Extreme market volatility
  • Flash crashes
  • Market manipulation attempts
  • Systemic market failures

Impact on Traders ​

ADL affects traders in a specific order:

  1. Higher Leverage First: Traders with higher leverage positions are affected first. This is because they represent higher risk to the system.

  2. Profitable Positions: Contrary to what might be expected, ADL targets profitable positions first. This is because:

    • Profitable positions have the collateral to cover the forced closure
    • It's more efficient to close positions that can be closed without additional losses
    • It helps maintain the exchange's solvency by using existing profits to cover losses

  3. Order of Impact:

    • Highest leverage profitable positions are closed first
    • Then lower leverage profitable positions
    • This continues until the insurance fund is replenished or leverage is reduced to acceptable levels

Technical Implementation ​

In Perpetuity's implementation:

  • The system maintains minimum insurance fund requirements per market (e.g., $100,000 for Bitcoin, $70,000 for Ethereum and Solana)
  • The community fund acts as the primary insurance mechanism
  • ADL is part of a three-tiered liquidation system:
    1. Orderbook liquidations (normal market conditions - will be built post alpha)
    2. Backstop liquidations (when orderbook is insufficient)
    3. Auto-deleveraging (extreme conditions)

This layered approach ensures that ADL is truly a last resort, only activated when all other risk management mechanisms have been exhausted.