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Apr 09, 2024
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Understanding How Liquidations Work on Orderly Network
by Orderly Network
Understanding How Liquidations Work on Orderly Network

Many perpetual futures traders are probably familiar with the concept of “liquidation” due to swift price swings. Liquidation occurs when a trader’s Account Margin Ratio (AMR) falls below its Maintenance Margin Ratio(MMR). AMR refers to a measure of the amount of margin currently utilized in a trading account relative to the total value of the positions held in the account, while the MMR represents the minimum level (usually set by the broker) to which the AMR must be maintained to avoid liquidation.

Centralized liquidation is the standard mechanism in traditional finance (TradFi) and crypto. This mechanism makes brokers the absolute deciders during liquidation. During liquidation, brokers often close traders’ positions at the last price, leaving them with no option in the entire process. This unfavorable liquidation mechanism requires an overhaul through the introduction of a new liquidation system that is;

  • Fully Decentralized: where liquidated positions can be transferred to liquidators at fair prices instead of being market sold in the orderbook.
  • Operates fair pricing: where the perps contract value is estimated using signals from several spot markets to generate a fair Mark price.
  • Highly flexible: where liquidators can choose to take up a liquidated position partially or fully.

A fully decentralized liquidation system gives traders an alternative when taking a loss on a trade. It offers flexibility by giving other traders the chance to take on a position once they meet the requirements for such trade.

Orderly Network has an inhouse decentralized liquidation mechanism that addresses trade liquidations. The decentralized liquidation mechanism offers an alternative to traders by enabling them to take over a liquidated position when they meet the requirements for such positions.

Orderly operates a fully decentralized liquidation system where any trader with an Orderly account can act as a liquidator when they hold the adequate margin-to-maintenance ratio to take on a liquidated position.

How it Works

  • Liquidation trigger: Orderly triggers a liquidation process when a trader’s Account Margin Ratio falls below their Maintenance Margin Ratio.
  • Liquidation tiers: A liquidator takes over a position based on the risk tier category. Positions are categorized as either High or Low Risk depending on the trading pair.
  • Liquidation amount: Orderly calculates the amount of position that should be liquidated and transferred based on the trading pair’s risk category.
  • Liquidator takeover: The liquidator partially or fully takes over a liquidated position, depending on their account margin ratio.

The liquidation process begins when Orderly triggers a liquidation on an account that has fallen below its maintenance margin ratio. At this point, a liquidated position can be taken over by any trader on Orderly at a discount.

Orderly classifies positions as either high or low risk depending on the trading pairs. BTC and ETH are low-tier risk trades, while other trading pairs are high-tier risk trades. A liquidator will be able to claim a ratio of all symbols for low-risk assets, while they can only claim one symbol in the high-risk trading categories.

Orderly then calculates the amount of position that should be transferred to the liquidator by estimating their account margin ratio in comparison to the maintenance ratio of the liquidated position. Orderly only permits a partial liquidation if an account has multiple positions in low-risk pairs. The minimum notional for a partial liquidation for low-tier risk pairs is 10,000 USDC, while high-tier pairs stand at 5,000 USDC.

Lastly, a user liquidation fee is incurred, which is split between Orderly’s Insurance Fund and the liquidator.

Orderly’s decentralized liquidation system has reimagined how liquidation works in crypto trading. It offers a lifeline to traders through a fair price model that gives traders the flexibility to take over a liquidated position either fully or partially, contrary to the unilateral liquidation process that is prevalent across much of DeFi currently.

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