The margin system
Deribit is a leveraged exchange, therefore it is possible for traders to have considerably larger positions than their account balance. This leaves a chance, that the losing party on a particular trade cannot afford to pay the winning party if they run out of margin.
This risk is initially mitigated by the margin system whereby all traders with an open position are required to keep a certain amount of maintenance margin in their accounts to support their position in case the market moves against them. The precise level of margin depends on the instrument being traded and the size of the position, and updates in real-time as the markets move.
If a trader runs out of margin they will be liquidated and their side of the position will be distributed to another trader who does have the required margin to take on the position from that point.
However, what happens when there is a difference between the price at which the losing trader is liquidated and the price at which another trader takes over the position?
How does the system make sure that the trader on the winning side of the trade still gets paid?
The insurance fund
This is the function of the insurance fund. The insurance fund covers the deficit, ensuring that the winning trader receives the full payout and that the losing trader is not in debt.
On brokerages, mostly used in the traditional financial sector, if the account reaches negative equity, i.e. you lose more than you had deposited, you are still liable for losses. On Deribit, your account might have negative equity, however, the insurance fund will be used to set it back to zero. In this sense, the insurance fund system provides negative balance protection for traders that get liquidated and ensures the payout to the counterparty of the contract.
From the profitable trader’s point of view, the insurance fund ensures that they get paid in full. From the liquidated trader’s point of view the insurance fund ensures that even though their position lost more than they deposited, they are not in debt and do not need to deposit more to cover the difference.
What is the insurance fund not used for
The insurance fund is not used to cover traders’ losses. Its only purpose is to cover any difference between the bankruptcy price and the execution price of the liquidation order. Traders will not get any of their initial losses back from the insurance fund, they are simply protected from having a negative balance.
So where does this money come from? Money doesn’t grow on digital trees either!
Every time a liquidation order is executed, an extra fee is paid on top of the normal trading fee. This fee is only paid by positions that are in the process of being liquidated.
The liquidation fee is then transferred to the insurance fund, raising the insurance fund balance. The insurance fund increases with each liquidation order, big or small.
The socialised loss system
We now have covered how the insurance fund operates and its funding mechanism, but what would happen if the insurance fund ever ran out of funds?
All trading on Deribit is peer to peer, meaning the person taking the other side of your trade is simply another trader, rather than Deribit itself. Therefore, when the insurance fund has been depleted, any loss will be socialised. Loss socialising is a process whereby any deficit, that cannot be covered by the insurance fund, is redistributed among the profitable traders from that session.
Example:
Let’s imagine a massive, rapid price move resulting in a large number of bankruptcies, that causes full depletion of the insurance fund. At the end of this trading session, there is still a deficit of 10 BTC, meaning the profitable traders of this session are still owed 10 BTC. In this situation, this 10 BTC deficit would be proportionally distributed between the traders who made a profit that day, meaning they still get paid, but not the full amount.
You can think of the insurance fund as additional protection against the above-mentioned scenario. Deribit’s margin system combined with the incremental liquidation system are what ensure the lowest possible number of liquidations happen at a worse price than the bankruptcy price. The insurance fund is there just in case there is still a deficit after the liquidation process.
You can learn more about the liquidation process in our tutorial on liquidations.
Daily settlement
To ensure the socialised loss process would not disproportionately affect longer-term traders who hold trades for multiple days or even months, Deribit has a daily settlement system. Every day at 08:00 UTC, as long as the insurance fund has not been depleted (i.e. there is no socialised loss situation), all the profits from futures or perpetual contracts from the previous session are fully transferred to traders’ cash balances.
To this day, Deribit has never had an instance of socialised loss.
It’s important to be aware that in the absence of a socialised loss event, these daily settlements are merely a background accounting entry in the transaction log. They have no effect on the profitability of your positions. At the time of writing, only futures and perpetual contracts have daily settlement entries in the transaction log.
The resulting daily sessions
If there has never been a socialised loss on Deribit, what does this mean in practice for my account?
There is one major difference you will notice in Deribit’s UI that may not be present in other exchanges you have used, and this is the daily sessions.
‘Session’ profits come in the form of session UPL (unrealized profit and loss) and session RPL (realized profit and loss). Both of these figures are calculated from the previous daily settlement at 08:00 UTC and reset to zero every day at the same time.
Session UPL is the unrealized profit and loss for that day’s session, in other words, how much profit the currently open position has made since the previous 08:00 UTC daily settlement.
Session RPL is the realized profit and loss for that day’s session, in other words, how much profit has already been ‘locked’, by closing part of the position for example, since the previous 08:00 UTC daily settlement.
Both session UPL and RPL are figures calculated since the time of the previous daily settlement, not over the whole life of the trade. Therefore, it is very common to see UPL and RPL figures that differ from the total profit/loss given in the PNL column.
Example:
Trader opens a long 1 BTC position on a BTC/USD futures contract.
On the first day, the price moves up by $100. At this point, both the total PNL and the session UPL are the same at $100. At the next daily settlement at 08:00 UTC, the price is still up $100, but the session stats are reset to zero for the start of the new session. At this point, the PNL will still be $100, but the UPL will be $0.
On the second day, the price continues to increase and is up by another $50. At this point, the session UPL will be $50, and the total PNL will be the sum of both days, $150. At the next daily settlement, the session UPL is again reset to $0.
On the third day, the price moves in the opposite direction and decreases by $20. At this point, the session UPL will be -$20 (a $20 loss). The total PNL though will still show the sum from all three days since the opening of the trade i.e. $100 + $50 – $20 = $130.
On each of these days, any session profits are not available for transfer or withdrawal until after the next daily settlement at 08:00 UTC.
In the example above, the trader made $100 profit on the first day, however, this would not have been available for withdrawal until the settlement at the start of day two. Similarly, when $50 profit was made on the second day, this would not have been available for withdrawal until after the settlement at the start of day three and so on.
This restriction only applies to session profits. Any existing funds or previous day’s profits are available for withdrawal at any time (unless they are being used as margin for other positions). It should also be noted that even though profits can be withdrawn only after the daily settlement, all funds, including session profits, are available to use for trading at any time.
Summary
- The deribit insurance fund ensures payout to profitable traders even when liquidated traders go bankrupt.
- The insurance fund does not cover the losses of liquidated traders.
- It is funded by the liquidation fee added to all liquidation orders (not just the trades resulting in bankruptcy).
- All daily profits/losses are transferred to the trader’s cash balance at the daily settlement at 08:00UTC.
- Any profits of the day are available for withdrawal after the daily settlement.
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