The insurance fund is used to protect traders from bankruptcy in the event of liquidations, preventing their positions from being taken over by the auto-deleveraging system (ADL) when the positions cannot be closed at the bankruptcy price. The insurance fund mainly grows from liquidations that were executed at a price better than the bankruptcy price, and the fund's balance is disclosed to the public.
The insurance fund serves the following two purposes:
- The fund covers the extra losses incurred in extreme cases where a position is liquidated at a price worse than the bankruptcy price;
- It minimizes the occurrence of auto-deleveraging of counterparty positions when a position is liquidated at a price worse than the bankruptcy price.
The balance of the insurance fund increases or decreases due to the following factors:
- The insurance fund is initially funded by the platform;
- The insurance fund receives money when a position is liquidated at a price better than the bankruptcy price;
- The insurance fund loses money when it is used to cover extra losses and the funding rates that a trader fails to pay due to liquidations executed at a price worse than the bankruptcy price.
After a position is taken over by the liquidation system, it will be closed at the bankruptcy price. The bankruptcy price is the price level at which a trader's losses equal their initial margin and their net asset is then reduced to 0.
- The remaining margin is added to the insurance fund if the position is closed at a price higher than the bankruptcy price.
For example, a trader opens a long position in BTCUSDTPERP and the margin is 200 USDT, with a liquidation price of 9,000 USDT and a bankruptcy price of 8,900 USDT. Once the mark price of the position hits 9,000 USDT, liquidation will be triggered. In this case, if the position is closed at a price higher than 8,900 USDT, the remaining margin after liquidation will be contributed to the insurance fund.
- On the other hand, if the final execution price is lower than the bankruptcy price, the insurance fund will be applied to cover the losses, protecting traders from negative equity.
- If the insurance fund is not sufficient to cover the extra losses, the ADL system will be triggered and automatically deleverage counterparty positions.
Sufficient insurance funds may reduce the occurrence of ADL. Traders may view Poloniex's insurance fund history here.