Auto-Deleveraging (ADL)

Overview of Insurance Funds and Their Challenges

Insurance funds in trading platforms are established to address insolvency risks, which arise during substantial market movements leading to trade bankruptcies. These funds serve as a financial buffer, bridging the gap between a trade's bankruptcy price and the feasible exit price to a solvent trader. The primary issue with these funds is the risk of insolvency. This situation is akin to a Uniswap pool that inconsistently returns tokens during swaps. To be a dependable trading system, it's crucial that traders consistently receive their due rewards.

Argon Protocol's ADL Approach

Argon Protocol sidesteps the need for an insurance fund through a risk-tranched Auto-Deleveraging (ADL) system. This innovative system permits the direct closure of trades against a corresponding counterparty trade on Argon Protocol, bypassing conventional liquidity pools like Uniswap.

For example, if there's a need to close a 10 ETH long trade that cannot exit on Uniswap, and a matching 10 ETH short trade exists, Argon Protocol can close these positions against each other. This procedure doesn't affect the exposure of Argon Protocol LPs since it does not involve swapping on Uniswap. Typically, the trade being forcibly closed by ADL receives a better price than if it had closed organically in the market.

Avoiding ADL

Most traders can avoid being subjected to ADL. ADL selections are based on risk tranches, with trades of higher leverage being more susceptible. As such, a trade with 75x leverage faces a greater likelihood of ADL compared to one with 10x leverage.

Profiting from ADL

In scenarios where a trade is ADL'd due to liquidation, it closes near its bankruptcy price, rather than the liquidation price. This means that a trade on the brink of liquidation with 4% collateral remaining might close at a price around 3 - 3.5% better than a standard market closure. This premium compensates the trader for the forced closure. In practical terms, a 20x leveraged trade undergoing ADL could result in a profit of 60-70% over a normal market closure.

ADL Triggers

ADL is triggered when a trade cannot execute a buy or sell order through Uniswap, often due to Argon Protocol not having the necessary tokens to complete the trade, leading to a Uniswap revert. Other triggers include insufficient liquidity in Uniswap, unknown reversion reasons, or the trade itself being bankrupt.

Handling Bankruptcy

If a trade cannot be liquidated while still having enough collateral to offset its loss, it is deemed bankrupt. These trades are liquidated via ADL at their bankrupt price. While this is not ideal for the trade being forcibly closed (as they might receive a worse price than in a self-initiated closure), it's a necessary measure. If there are no suitable trades to offset against, the bankruptcy loss is absorbed by Argon Protocol LPs, and the process ends there.

Through this approach, Argon Protocol effectively manages insolvency risks without relying on a traditional insurance fund, thus maintaining a more robust and trustworthy trading environment.