A Deleverage Event is a risk measure that Everstrike employs in order to limit socialized losses. A Deleverage Event happens when all of the following conditions are in place (at the same time):
- A trader has gone bankrupt
- The trader cannot have his position sold off at its Bankruptcy Price.
- No Liquidity Provider is willing to take over the position.
- The Everstrike Insurance Fund does not have sufficient funds to cover the loss on the position.
The first condition happens because the trader has the price move against him, and because he does not top up his Gross Position Margin in time. Eventually, his remaining equity will be 0, and he will be bankrupt.
The second condition happens because the market is moving extremely fast in one direction. The Liquidation order fails due to a lack of people willing to go long (if the bankrupt trader is short) or short (if the bankrupt trader is long).
The incremental nature of Everstrike's liquidation system ensures that the these conditions are unlikely to happen in practice. Most positions are only reduced a small amount at a time, making the liquidation orders more likely to be filled, and minimizing their influence on the market.
Risk Limits provide additional assurance by ensuring that larger positions have higher Maintenance Margin requirements than regular positions. This gives the liquidation engine more time to bring these positions back to normal.
While the third and fourth conditions could potentially happen in isolation, they are unlikely to happen simultaneously. The Everstrike Insurance Fund is funded by fees from liquidation orders. The fees are set so that it should always have a positive, increasing balance. If it does become empty at some point, a Liquidity Provider will generally be able to take over the bankrupt position.
The fact that all of these conditions need to be in place simultaneously makes Deleverage Events unlikely to happen in practice.
Socialized Loss
Under a socialized loss scenario, as seen on other exchanges, the bankrupt position would be sold at a loss. The loss would then be socialized among the winning traders. In other words, they would be given a haircut. The haircut would usually take place within 24 hours of the bankruptcy happening, but could be delayed up to 7 days. The longer the winning traders have to wait before their haircut, the more they risk losing.
The Alternative
With Deleverage Events, there is no haircut. When a Deleverage Event takes place, the position of the bankrupt user is closed out automatically, at its Bankruptcy Price. This is done internally by the Everstrike Deleveraging System. The system will also select one or more counterparties to the bankrupt user, and close out the position of these counterparties. The counterparties selected are the counterparties with the highest leverage and the highest profit. Traders that do not use high leverage have a very small chance of ever becoming the subject of a Deleverage Event. The selection formula is as follows:
Likelihood = Leverage * Position size * Return on Equity (ROE)
Checking Deleverage Events
Deleverage Events are visible in your trade history. If you are selected for an event, you will also receive a detailed email notification.