Insurance Funds

An insurance fund is a reserve pool of assets maintained by a derivative protocol to cover losses that occur when a bankrupt trader's position cannot be fully liquidated. When a trader's account balance falls below zero, the protocol uses these funds to ensure the counterparty receives their full profit.

These funds are typically built up through a portion of liquidation fees or excess spreads collected during normal market operations. By acting as a buffer, the insurance fund protects the protocol from becoming insolvent due to sudden market crashes.

It effectively limits the need for socialized losses, providing a more stable environment for traders. The size and management of this fund are critical metrics for assessing the safety of a decentralized exchange.

If the fund is depleted, the protocol may trigger more aggressive risk-sharing mechanisms to maintain balance.