🦺Loss Protection
A novel mechanism that rewards contrarian traders who help balance platform open interest skew
Loss Protection: A Skew-Adjusted Incentive for Traders
To further stabilize the market and protect LPs and traders, we've introduced a novel skew-adjusted loss protection feature. Specifically, traders on the less skewed side of the market will receive guaranteed rebate on trading losses. These rebates are tiered based on the market skew at the time of opening the trade (net of the trade's impact on skew):
This incentive for traders on the non-skewed side will encourage a more balanced distribution of open interest, minimizing risk for liquidity providers and bolstering the overall stability of the protocol. It also allows for several novel directional and arbitrage trades ! See below for some examples on how loss protection works:
Scenario: 85% of the platform's open interest is long $ETH, and 15% is short $ETH. Example 1: A brave directional trader (or hedger) wants to short $ETH with $10,000 of collateral. In this case if the trader gets liquidated, we give him back $3,000 of his collateral.
Example 2 (Directional Trader): If the net PnL of the above trader is -20%, then technically the trader should have lost $2,000 (20% of $10K). However, with loss protection, the trader only loses $2000 * (1-30%) = $1,400. This is the magic of loss protection !
Example 3 (Modified Basis Trade): Loss protection can also be used to open a "modified basis trade". When OI is skewed (i.e not balanced), basis traders generally go long on an asset on one exchange, and short on the same asset such that they're delta-neutral, but are collecting "funding fees". Given funding fees are variable (so the arb goes away), in a bull-market, a basis-trader could instead go short the same asset on Avantis, and close the trade if the price moves down. This gives the trader the loss protection incentive while remaining delta neutral.
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