Bankruptcy

A Margin Account is bankrupt when its Margin Account Equity (MAE) < 0. While the Maintenance Margin Requirement (MMR) and the liquidation auction mechanism exist to prevent bankruptcy, they cannot guarantee full risk mitigation — especially in fast-moving or illiquid markets. Thus, the (AFP) defines how bankruptcies are resolved when they do occur.

The AFP does not impose a protocol-endogenous Default Fund - a shared pool that absorbs losses from bankrupt accounts – as this approach has two key shortcomings:

• Insufficient Guarantees: There is no assurance the default fund will always be sufficiently capitalized.
• Economic Inefficiency: A one-size-fits-all insurance model imposes costs on users who may not value the coverage, which results in higher fees to the end-user.

However, third-party insurance layers can still be built on top of the AFP if market demand exists for such products.

Auto-deleveraging

Instead of socializing losses across all traders, as is the case with a Default Fund, the AFP uses an auto-deleveraging mechanism as a first resort, not a last resort. Losses from bankrupt accounts are absorbed directly by other margin accounts with opposing positions in the affected products.

Which accounts absorb the losses?

Losses related to auto-deleveraging are not socialized across the entire protocol. Instead:

• Only margin accounts with opposing positions in the same products as the bankrupt account are eligible to absorb the loss.
• Margin accounts with positions in unrelated products are never impacted.

These constraints are critical to supporting permissionless market creation, as they isolate risk within products and prevent contagion across the entire system.