Default Prevention

Default prevention in the CVEX Protocol is a mechanism designed to mitigate risks associated with traders' limit orders. Given the sophisticated and dynamic margin requirements on CVEX, which depend on contract volatility and price correlations, the pre-allocation and reserving of collateral for placed orders can lead to challenging margin requirements. These requirements might vary significantly over time due to changing market conditions or alterations in portfolio exposure.

To address these complexities, CVEX has implemented a proactive Default Prevention system. This system monitors and manages all limit orders across the platforms. Before placing a limit order in the order book, the protocol evaluates initial margin requirements for the trader's current portfolio as if the order were executed under prevailing market conditions. If the margin requirements are satisfied, the order is placed in the order book, and default prevention monitoring commences.

Default Prevention System

The primary function of this mechanism is to pre-emptively terminate limit orders that, if filled, would likely lead to the trader’s liquidation. Clearance Bots actively monitor limit orders to identify those meeting two conditions:

  • High Probability of Execution: Orders that have a significant likelihood of being executed within a specified timeframe and confidence level, as determined by the VaR risk parameters from Risk Oracles, are targeted. Only orders close to execution are considered for termination.

  • Impact on Margin Ratio: Orders that, upon execution, would cause the trader's margin ratio to exceed 100% are flagged.

When both conditions are met, Clearance Bots initiate the order's termination, with the protocol executing it after deterministically verifying the conditions. Clearance Bots receive compensation for their services, covering the gas used and an additional premium paid from the Platform's Operational Fund.

Operational Mechanics and Incentives

When orders are terminated by the protocol, as opposed to being cancelled by traders, the trading fee is not reimbursed. Instead, it is paid to the Clearance Bot that initiated the termination. This system fulfils dual purposes. Firstly, it encourages traders to actively monitor their limit orders and maintain sufficient collateral for potential execution. Secondly, it encourages proactive participation from Clearance Bots in default prevention by timely terminating orders, creating a competitive environment for them to earn rewards from terminated orders.

This proactive approach helps ensure that traders maintain sufficient collateral to manage risks across their portfolio and all placed orders. Moreover, it effectively reduces the frequency of liquidations by pre-emptively terminating limit orders that pose a high risk of triggering them. Default Prevention, therefore, is instrumental in maintaining a stable and efficient trading environment on the CVEX Platforms, balancing effective risk management with optimised trading opportunities for its participants.

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