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Liquidity Vault Risks

Risk​

Platform Risks

To fully understand the risks of providing liquidity to the vault, we encourage you to review exchange risk.

When traders win, the vault pays them.

If traders win more than they lose, the vault's balance will decrease. If the efficient-market hypothesis holds, Domination Finance's traders cannot implement price-based trading strategies that "beat the market" in aggregate. However, if there existed trading strategies that did not depend on price movements, traders could profit over time.

To mitigate price-independent trading strategies, Domination Finance implements

  • A minMargin for trades. Right now, Domination Finance runs a liquidator bot that will liquidate any position that drops below the liquidation threshold. But when liquidations are decentralized, liquidators will only liquidate positions if doing so is profitable: if liquidator rewards are greater than the gas required to liquidate. Without a minMargin, traders could open many tiny longs and shorts that would never be processed by community liquidators. Such positions could be held open indefinitely until they eventually became profitable, draining value from the vault as prices fluctuated up and down. Since liquidation is currently centralized, and the Domination Finance team will process even unprofitable liquidations, minMargin is 0 for a better trader experience.
  • A minProfitChange for each product. Unless price has changed by more than this amount, or minProfitTime has elapsed, positions cannot be closed with a profit. Domination Finance uses a push oracle: price changes triggers new transactions that update the on-chain oracle price. It would be uneconomical to update the oracle every block, so we update the oracle every few minutes, or immediately once the price changes beyond a certain threshold. Without minProfitChange, traders could notice a price change beyond the oracle update threshold, open a position at the old price, and close the position to profit once the regularly-scheduled oracle update occurred. Currently, minProfitChange is 1.5% for all products and minProfitTime is 6 hours.

Even if traders lose in the long run, one big win or group of wins could result in a temporary decrease in liquidity and cause a liquidity crisis. To reduce this risk, DomFiVault implements several controls to limit outstanding positions relative to vault liquidity:

  • Positions cannot be opened or increased if doing so would raise the total open interest across all products beyond utilizationMultiplier times the vault balance. Currently utilizationMultiplier is 10x.
  • Positions cannot be opened or increased if doing so would raise a product's exposure beyond productExposureMultiplier * maxExposureMultiplier times its share of vault balance. Currently maxExposureMultiplier is 3x, and productExposureMultiplier is 5x for BTCDOM, 2.5x, for ETHDOM, and 1.5x for USDTDOM, BNBDOM, and SOLDOM.

And to further reduce volatility in trader PnL,

  • Position leverage is limited to 20x.
  • Each product has its own liquidation threshold, which allows positions in very volatile products to be safely liquidated before falling underwater. Currently all products have a liquidation threshold of 70%.

Finally, when exposure is high LPs will tend to win or lose as prices change. Liquidity providers want consistent returns, but high exposure would cause performance to change across different market conditions. To reduce this tendency, Domination Finance incentivizes low exposure (balanced longs and shorts) within products:

  • Funding rates pay minority positions and penalize majority positions, incentivizing low exposure
  • Price impact gives worse prices to orders that would increase exposure
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