Dec 04, 2023
Product
Orderly Network’s Liquidation Engine: A Deep Dive for Crypto Traders
by Orderly Network
In our earlier post, we shed light on the important role that the liquidation engine plays in preventing losses for traders and a crypto exchange. We explained what a liquidation engine is, how it works, and its key components. This article centers on Orderly’s liquidation engine. Most importantly, we explore how our decentralized liquidation engine model differs from existing centralized systems, and how it further helps traders whose trades have entered a liquidation position.
Orderly Network employs a robust liquidation mechanism to protect traders from significant losses. A user’s account becomes subject to liquidation if its Account Margin Ratio (AMR) falls below the Maintenance Margin Ratio (MMR). The Mark Price, derived from reputable spot exchanges and the funding rate, is utilized to represent a contract’s estimated value. This approach minimizes volatility compared to the Last Price, discouraging market manipulation tactics to trigger liquidations.
We derive the Mark Price using the formula below:
Median Price = Median(P1, P2, Futures Price)
Where:
P1 = Index Price * (1 + Last Funding Rate * Time until next Funding / dt)
P2 = Index Price + 15 Minute Moving Average[Basis]
Futures Price = Median(Bid0, Ask0, Last_Price)
The Last Funding Rate is expressed on an 8hour basis, where:
Basis = Median(Bid0, Ask0) — Index Price, calculated as a snapshot every minute
dt = Funding Period = 8 hours
When an account undergoes liquidation, Orderly automatically cancels existing open orders and freezes the USDC balance on the trade. This proactive measure helps prevent further losses and ensures a fair liquidation process.
In contrast to centralized exchanges (CEXs) and a handful of decentralized applications, Orderly adopts a fully decentralized liquidation model. Therefore, Orderly operates a system where positions are transferred to liquidators at a discounted rate. This contrasts with practices by CEXs where positions are closed without taking traders into consideration. This way, we are able to prevent further liquidations and market manipulations.
Additionally, any user with an Orderly account can become a liquidator, provided their account has sufficient margin to take over the liquidated positions. This inclusive approach enhances market fairness and eliminates the concentration of liquidation power in the hands of a crypto exchange. Our approach also limits cascading liquidations since the positions are not sold off but rather transferred.
Furthermore, our infrastructure features a failsafe mechanism for liquidations on Orderly Network. In a case where no liquidator takes over the position within a certain time frame, our insurance fund takes that position over and liquidators can take over positions from the insurance fund. Also, If certain conditions get met (like insurance fund dropping by x% in x% or AMR drops below MMR), the ADL kicks in — thus, socializing the losses.
Liquidators can take over a liquidating position either partially or fully. Each takeover has its own requirements, which are explained below;
A liquidator will be able to take over a liquidating position on a partial basis if the position is at least 10,000 USDC and above. In this instance, the liquidator can choose to take over a percentage of the entire position of the liquidated user.
For positions below the 10,000 USDC threshold, the liquidator must take over all positions of the liquidated user.
Caveat: Prior to transferring positions, Orderly conducts thorough margin checks to ensure the liquidator can effectively manage the acquired positions.
Orderly Network’s decentralized liquidation model brings a myriad of benefits to crypto traders by setting a new standard for fairness and efficiency in the market. Orderly’s approach minimizes the risk of cascading liquidations and market manipulation during turbulent market conditions.
By transferring liquidated positions to any user with an Orderly account, the platform promotes decentralization, ensuring that the power to act as a liquidator is distributed among a diverse set of participants. This not only mitigates the concentration of influence but also fosters a more democratic and inclusive trading environment where traders, irrespective of their account size, can actively participate in the liquidation process.
Furthermore, the decentralized liquidation process on Orderly Network adds an extra layer of security and transparency. The discounted takeover of positions by liquidators incentivizes responsible risk management, as these actors must have sufficient margins to absorb the liquidated positions. This ensures that only well-capitalized and prepared users participate in the liquidation process, reducing the likelihood of systemic failures.
Additionally, the decentralized nature of Orderly’s liquidation mechanism minimizes the impact of market manipulation, as positions are not directly closed on the order book. This innovative approach aligns with the principles of blockchain technology, providing a more resilient and equitable trading infrastructure for crypto traders. In embracing decentralization, Orderly Network stands as a pioneer in reshaping the dynamics of position liquidation in the cryptocurrency landscape.
Orderly Network’s approach to position liquidation sets it apart in the crypto space, offering a decentralized and inclusive solution. Traders benefit from a more transparent and fair process, reducing the risk of market manipulation during liquidation events. Understanding these nuances is essential for crypto traders navigating the ever-changing dynamics of digital asset trading on Orderly Network.
