Auto-Deleveraging Systems

Auto-deleveraging systems are mechanisms that automatically reduce the positions of profitable traders to cover the losses of bankrupt accounts when the insurance fund is insufficient. This is often seen as a last-resort measure in derivatives trading to prevent the protocol from entering a state of insolvency.

When the insurance fund is exhausted, the system matches the bankrupt position with the positions of the most profitable traders, effectively closing them at the bankruptcy price. While this maintains the solvency of the protocol, it introduces a significant risk for profitable traders who may have their positions closed unexpectedly.

This creates a socialized risk environment where traders are exposed to the failure of other participants. To mitigate this, platforms often use complex priority queues to determine which positions are deleveraged first.

It is a highly controversial but necessary feature for platforms that do not want to rely on centralized bailouts.