Insurance Fund
An insurance fund is a reserve set aside by a cryptocurrency exchange or trading platform to protect against losses from liquidations, unexpected events, or other risks.
The purpose of an insurance fund is to cover the deficit that may occur in the event of forced liquidation of leveraged positions or unexpected market volatility that leads to substantial losses for traders. It acts as a safeguard to ensure that traders' positions can be settled even if insufficient funds are on the losing side of a trade. Insurance Fund will pay on behalf of the counterparty in case of default.
If the Insurance Fund is depleted, the exchange forces the position of the opposing trader to cover the position of the bankrupt trader. This is called Auto Deleveraging Liquidation.
Basic Mechanism
When the liquidation occurs, the liquidation engine automatically unwinds the position. In this process, the Insurance Fund Mechanism varies depending on whether the execution price is above or below the bankruptcy price.
1. Execution Price > Bankruptcy Price (For Long position, Short position vice versa)
If the position is executed above the bankruptcy price, margin remains. The remaining margin will go into the Insurance Fund
2. Execution Price < Bankruptcy Price (For long position, Short position vice versa)
If the position is executed at a lower price than the bankruptcy price, losses will occur. The loss incurred will be covered by the Insurance Fund
Example
Trader A holds a long position on BTCUSDT perpetual swap, which has a liquidation price of 30,000 USDT, and a bankruptcy price of 25,000 USDT.
- If the liquidation engine unwinds the position for 27,000 USDT, it would leave a 2,000 USDT margin. The remaining margin will be sent to the Insurance Fund.
- If the liquidation engine unwinds the position for 24,000 USDT, it would result in a 1,000 USDT loss. Therefore, this loss is covered by withdrawal from the Insurance Fund.
Note: On the Flipster platform, the Backstop Liquidity Provider rather than the liquidation engine unwinds the liquidated position.
Risk Warning:
Trading in cryptocurrency involves risk and potential losses. Before trading, please make your investment decisions cautiously by considering your investment objectives, experience, and risk tolerance. You are solely responsible for your investment decisions, and Flipster is not liable for any losses you may incur. Derivatives trading, in particular, is subject to high market risk and price volatility. Please obtain independent advice where appropriate. This information should not be construed as financial or investment advice.