Most of the time, the market should just work fine, also our extremely efficient engine makes socialised loss rare. However, when the market becomes extremely volatile and the market is not liquid enough, users' positions may not be liquidated in time and thus their account balance may not be able to cover all their loss, which leaves risk to their counter-parties. We use socialised loss to solve this problem. Socialised loss applies to futures and options but not spots or binary options.
The main idea is that we use first an Insurance Fund to cover those who get bankrupted. If the Insurance Fund is not enough, then the profit of those wining trades will be discounted to account for the defaulted amount.
In order to implement our socialised loss scheme, the profit of a closed position needs to be locked (shown as Realized P/L on the trading interface) until the position expires.
When option/future contracts expire, we calculate the profit/loss of every user's expired position and divide the users into two groups:
- Those who made profit with this instrument
- Those who had a loss
We define Total Profit as the total profit made by users in group 1 through trading this instrument.
Users in group 2 may have got bankrupted if the market is extremely volatile and the liquidity is scarce. We define Total Default Amount as the absolute value of the sum of the negative equities of users in group 2.
We first try to use our Insurance Fund to cover the default amount. Therefore, if Total Default Amount is less than of equal to our Insurance Fund, the loss will be deducted from the Insurance Fund, and thus no socialised loss process will be initiated.
If unfortunately Total Default Amount > Insurance Fund, we will first use all Insurance Fund to cover the default amount first, and the rest will have to be distributed to all users in group 1 on a pro-rata basis, which becomes the socialised loss.