Risk Stratification
Last updated
Last updated
Caution should be exercised when interacting with any smart contract or blockchain application. While risks are attempted to be mitigated through testing, audits and bug bounties, there is always a risk of vulnerabilities in smart contract code.
A non-exhaustive list of risks:
Smart contract risks
Counterparty risks: The ALP pool is the counterparty to traders, if traders make a profit that comes from the value of the ALP pool
Token risks: Bridged tokens may depend on the security of the bridge, pegged tokens have risks of depegging
While counterparty risk is attempted to be minimized through funding fees and price impact it is not guaranteed that long and short positions will always be balanced. An additional case to note is that if, for example, long positions happen to be balanced with high leverage short positions and there is a sudden price spike, the high leverage short positions could be liquidated, temporarily causing an imbalance of longs and shorts.
The centralized cryptocurrency market rapidly integrated the derivatives market onto its burgeoning landscape, particularly through futures and perpetual contracts. However, the associated settlement processes still lag far behind traditional financial standards, and several reasons account for this infrastructure's absence from centralized cryptocurrency exchanges, necessitating detailed explanation.
Firstly, let's consider the vertical integration of major DeFi brokers or "liquidity black holes." Utilizing clearing technology for efficient trading enables net position settlements, which, from the users' perspective, consolidate funds within a single system. Generally speaking, the risks associated with Perp Dex can be abstracted into two categories.
The first is protocol risk, encompassing the core capabilities of maintaining financial primitives. For synthetic assets like DAI or sBTC, questions arise regarding their anchoring mechanisms and the realization of their value. Regarding options contracts, what guarantees the exercise ability? Cash or physical settlement? In prediction markets, who determines outcomes, and do oracle machines require streaming data or one-time settlements? Are all contracts fully collateralized? All these considerations are based on actual smart contracts and foundational layer security.
On the other hand, clearing risk is an abstract form of protocol risk, willing to treat assets as similar or offsetting and committed to fulfilling user positions. Each protocol represents a unique set of tail risks for clearing agents. Brokers and their clients alike hope that protocol risks are mercilessly and fairly priced to avoid any bankruptcies when protocols deviate from their intended paths. Equally important for clearing risk is the actual modeling of related but different products. Consider Uniswap's ETH/DAI LP shares and 10x BTC/USDC longs on dydx. Calculating a low-risk and effective hedge is crucial here, requiring adept modeling of derivative tools and fundamentals.
Allspark currently addresses the latter, clearing risk category. Introducing risk stratification is a necessary measure to enhance the capital security of decentralized perpetual contract exchanges. Specifically, it involves splitting the ALP treasury into primary and advanced risk portions, each absorbing a different fixed percentage of traders' profits and losses. Additionally, the treasury includes an annual interest rate multiplier to incentivize LPs (liquidity providers) for partial rebalancing.
Enhanced Capital Security: Risk stratification enables exchanges to better manage and allocate risks. Allowing liquidity providers to select appropriate risk stratification for collateralization according to their risk tolerance reduces capital risk.
Personalized Risk Management: Risk stratification allows traders to choose different leverage ratios based on their personal risk preferences and investment strategies, enabling personalized risk management. This enables traders to more accurately control their trading risks, aligning with their risk tolerance and investment goals.
Reduced Systemic Risk: By dispersing the risks of traders and liquidity providers across different risk layers, risk stratification helps reduce the overall system's risk exposure. Even if adverse events occur in one risk layer, others can remain relatively stable, reducing the spread and impact of systemic risks.
