Liquidation Mechanism

Partial Liquidation First

When a position breaches maintenance margin:

Step 1: Partial Reduction

  • Position is reduced proportionally

  • Goal: Restore account to safe margin levels

  • Minimizes capital loss for trader

  • Prevents unnecessary full liquidations

Step 2: Full Liquidation (If Needed) Only if partial liquidation insufficient:

  • Entire position closed

  • Liquidation penalty applied

  • Insurance fund covers any shortfall

Liquidation Penalty Calibrated to:

  • Prevent predatory liquidations

  • Discourage excessive leverage

  • Ensure liquidators have incentive

  • Maintain system health


Insurance & Backstop Mechanisms

Insurance Fund

  • Protocol-owned reserve funded by liquidation penalties

  • Covers losses when liquidations occur below maintenance margin

  • Transparent balance published on-chain

Backstop Auction In extreme scenarios where insurance is insufficient:

  1. Position auctioned to liquidators

  2. Dutch auction format (price decreases over time)

  3. Ensures orderly liquidation even in illiquid conditions

  4. Protects against cascading failures

Social Loss Distribution Last resort if all backstops exhausted:

  • Losses distributed proportionally across profitable traders

  • Transparent and verifiable process

  • Historical precedent from successful exchanges


Liquidation Example

Scenario: Trader has 10 ETH-PERP long at $3,000 (30,000 USD position)

  • Initial margin: 10% ($3,000)

  • Maintenance margin: 5% ($1,500)

  • Current collateral: $2,000

ETH drops to $2,900:

  • Position value: $29,000

  • Margin requirement: $1,450 (still safe ✅)

ETH drops to $2,800:

  • Position value: $28,000

  • Margin requirement: $1,400

  • Liquidation triggered ⚠️

Partial Liquidation:

  • 5 ETH-PERP closed at $2,800 = $14,000 reduction

  • Remaining position: 5 ETH-PERP long

  • New position value: $14,000

  • Margin requirement: $700

  • Current collateral: $2,000 - loss

  • Account restored to health

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