Avantis Feature Deep-Dive Series #1: Loss Protection for Traders
Loss protection is a novel mechanism designed by Avantis, to incentivize traders to balance open-interest skew on the protocol
Long-Short Skew (LSR): What is it ?
In any derivatives trading platform, market-makers and traders should closely monitor the long-short skew. Long-short skew is the proportion of traders that are long or short an asset, as measured by the position size of all open trading positions.
On Avantis, this can be found for each market in the trading terminal, as shown below ($1.5M of open positions exist on the long side, and $940K of open positions exist on the short side, implying a long-short skew of 61% long, 39% short)
There are two important stakeholders that should care about the long-short skew (LSR):
- Traders: LSR affects hourly borrowing fees for margin traders. Since traders are borrowing USDC to leverage trade, they pay an hourly fee on the position size of their trades. When LSR gets extremely skewed (e.g 80% long, 20% short), short traders pay no margin fees. The margin fee for longs on the other hand spikes up exponentially the more long-biased a market gets.
- Liquidity Providers: LPs power all trades on Avantis, and ensuring balanced OI is essential to preserving their principal. When OI is imbalanced, existing LPs should get the benefit of increased borrowing fees on the skewed side.
Loss Protection: A Skew-Adjusted Incentive Mechanism for Traders
To further stabilize the market and protect LPs and traders, we’ve introduced a novel skew-adjusted loss protection feature. Specifically, traders on the less skewed side of the market will receive guaranteed loss protection, tiered based on the market skew:
This incentive for traders on the non-skewed side will encourage a more balanced distribution of open interest, minimizing risk for liquidity providers and bolstering the overall stability of the protocol.
Note: The same loss-protection will also apply to longs when the market is in a short-skew
Why not provide funding fees to non-skewed traders?
An important question that often comes up is why don’t we offer funding rates. Funding rates exist in traditional perpetual exchanges where the perpetual contract is priced based on supply and demand, and a fee (the funding rate) is charged to ensure that the price of the perpetual contract (“mark price”) does not stray too far away from the price of the actual asset (“index price”). There are two main reasons why funding fees don’t exist in Avantis (and why we charge borrowing fees, and offer loss protection incentives):
- In margin based perpetual DEXs like Avantis, trades are priced using oracles, which means that the “mark” and “index” price are always the same. Moreover, every trade is powered by onchain LPs who provide the margin necessary for leveraged trading. Hence, while we could theoretically still charge hourly funding rates competitve with centralized exchanges, this would be a bit misaligned, as LPs are powering all trades, but the hourly incentive to skew trades back would go back to the trader, not the LP.
- Another reason for designing loss protection is the popular principle of loss aversion, as explained by the decision lab.
“Loss aversion is a cognitive bias that explains why individuals feel the pain of loss twice as intensively as the equivalent pleasure of gain. As a result of this, individuals tend to try to avoid losses in whatever way possible.”
While funding fees give temporary opportunities to make money for delta-neutral traders, it does not cater to directional traders. We want to empower directional traders to express their unique view on the market, while giving them loss protection incentives to help balance OI skew on Avantis.
Want to learn more about loss protection in a risk-free way ? Try it out on testnet beta https://www.avantisfi.com/trade
Avantis is a an advanced margin-based perpetuals DEX, built on Base. Trade cryptocurrency, forex and commodities with up to 100x leverage, or power trades on the platform as a liquidity provider. Avantis gives advanced risk management tools to traders and liquidity providers for the use and provision of trading leverage.
Our mission is to bring high-scale derivatives to the masses, by empowering anyone to become a market-maker and trader for complex instruments like perpetuals and options. Our first product (perpetuals) is currently live on Base Testnet.
