Deleveraging
Ensuring LPs are protected
Background
As established earlier, the hard skewness cap is an absolute limit on the market skewness that cannot be exceeded under any circumstances, even for "closing" or "liquidation" orders.
However, it is crucial to support closing and liquidation orders under all conditions to ensure market stability and protect the interests of participants.
Mechanism
To reconcile these requirements, the 'Deleveraging' mechanism is activated when the size of the skewness exceeds the soft skewness cap. Under this mechanism, positions on the skewed side of the market can be forcefully closed to bring the skewness back within acceptable limits.
This means that if the market is skewed towards the long side, some long positions will be forcefully closed.
Conversely, if the market is skewed towards the short side, some short positions will be forcefully closed.
Example
Let's illustrate this with an example:
Assume that the soft skewness cap is 1,000 ETH, the hard skewness cap is 2,000 ETH, and the current size of the skewness is 1,010 ETH (which means the soft skewness cap has been exceeded).
If a liquidation order is placed that would further increase the skewness, it would not be acceptable under normal circumstances because it exceeds the hard skewness cap.
However, since the 'Deleveraging' mechanism is activated, positions on the skewed side (in this case, long positions because the skewness is positive) can be forcefully closed to make room for the liquidation order and bring the skewness back within acceptable limits.
Conclusion
The 'Deleveraging' mechanism is a vital tool in Aark's risk management toolkit. It ensures that closing and liquidation orders can always be supported, even when the skewness exceeds the soft skewness cap. By forcefully closing positions on the skewed side of the market, it helps bring the skewness back within acceptable limits, thereby protecting the liquidity pool and ensuring the stability and sustainability of the Aark protocol.
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