An exchange insurance fund is used to cover any unexpected losses from leveraged trading. This fund is used to prevent traders from bankruptcy in the event of liquidations.
What Is Insurance Fund?
The insurance fund is fundamental to cryptocurrency derivatives exchanges and protocols. It acts as a defense against contract loss in leveraged trading and is used to pay the traders in the event of liquidations who fail to take measures in time to prevent their open positions from going bankrupt. Insurance funds are typically funded using exchange fees, liquidation penalties, or other means.
In leveraged trading, each position has a liquidation price and bankruptcy price. If a position’s liquidation price goes higher than its bankruptcy price, the position is closed and liquidated, with a portion of the remaining margin typically being added to the insurance fund. Conversely, if the liquidation price goes lower than the bankruptcy price, the insurance fund covers the loss.
Exchange operators and protocol designers must consider insurance fund health very carefully when designing, building, and operating an exchange offering leveraged trading in order to ensure the solvency of the exchange.
Author: Yenwen Feng – Co-Founder at Perpetual Protocol
Yenwen Feng is a cryptocurrency and technology professional with vast experience as a CEO and co-founder of several startups. Since 2004, Yenwen founded Decore (Stripe Atlas for Crypto Companies), Cinch Network (Decentralized Derivatives), Cubie Messenger (Mobile Messenger, 500 Startups B5, 10M downloads), Gamelet, and Willmobile (Top mobile financial service app in Taiwan, acquired by Systex). Since 2019, Yenwen’s acted as CEO and co-founder of Perpetual Protocol, a decentralized perpetual contract protocol.