Skewness Cap
A Key Protector for LPs.
Last updated
A Key Protector for LPs.
Last updated
In DeFi, protecting liquidity providers (LPs) from excessive risk is crucial for the success and scalability of any protocol. Most perp DEXs fail to safeguard LPs adequately as their skewness often reaches beyond 65-35, exposing LPs to significant directional risk. Instead, Aark leverages a unique mechanism called 'Skewness Cap' to safeguard LPs and enable the protocol to scale beyond other perps DEXs.
“Skewness” is defined as below.
'Skewness' indicates the directional risk exposure of the liquidity pool, reflecting the market's skewness. For example, if there are 100,000 ETH long and an equal amount short, the skewness is zero, indicating no directional risk exposure for the LPs.
Implementing a cap on skewness rather than on open interest (OI) is a strategic move that significantly increases OI scalability while maintaining the same low risk for the pool. For instance, a perpetual DEX with a $10m ETH OI cap without any skewness cap mechanism could easily have an 80:20 long-skewed OI balance, exposing the pool to a $6m short position. However, with a $6m skewness cap, the protocol can scale the OI up to $100m, where the skewness is $6m ($53m long - $47m short). Although the pool is exposed to a $6m short position in both cases, the latter case only exposes 6% (6m/100m) of the OI, compared to 60% in the initial case.
By implementing a skewness cap, the protocol not only substantially decreases the directional risk the pool takes on, but also increases scalability by more than 10x. This scalability is crucial for the foreseeable future, where perp DEX volume is expected to match or surpass perp CEX's.
There are two kinds of skewness caps: Soft Skewness Cap and Hard Skewness Cap.
The Skewness Cap is a core component of the Aark protocol, designed to protect LPs from excessive directional risk exposure while enabling the protocol to scale significantly. This mechanism is integral to the Aark flywheel, as it ensures the safety of the LPs, thereby attracting more liquidity to the platform. As more liquidity is provided, it supports more traders, reinforcing the flywheel effect and driving the continuous growth and success of the Aark ecosystem.
