ADL

ADL is a permissioned function, meaning only the market admin (or delegated parties) can execute it.

Execution Process

The execution follows a hybrid off-chain calculation and on-chain execution model:

1. Ranking (Off-Chain): Profitable positions are ranked based on factors such as profitability, leverage, and position size.

2. Selection: The top-ranked positions are selected to cover the specific amount of bad debt (e.g., 2, 3, or 4 positions).

3. Execution (On-Chain): The bad debt position is closed against the selected counterparties.

   • Zero PnL Impact: The closure occurs at the counterparty's average entry price, ensuring the counterparty realizes 0 PnL on the trade.

   • Collateral: The bad debt position's collateral is distributed to the counterparties.

Verifiability

While ADL execution is permissioned and depends on decided offchain factors, being fully onchain allows for the ADL result to remain fully verifiable.

Post-Execution Verification:

• All position data exists on-chain at the time of ADL.

• Anyone can reconstruct the position rankings as they existed at the moment of ADL.

• The community can verify that the admin selected the appropriate positions according to the published ranking criteria.

• Transparency: Index prices, position states, and all relevant data are immutably recorded on-chain.

• Accountability: While users cannot prevent ADL in real-time, any deviation from the published ranking algorithm is provably detectable after the fact. The community can reconstruct rankings and challenge improper executions.

Technical Implementation

The ADL ranking algorithm considers multiple factors:

• Profitability: Higher unrealized PnL increases ranking.

• Leverage: Higher effective leverage increases ranking.

• Position Size: Larger positions may be weighted in ranking.

For Profitable Positions:

For Losing Positions:

Where:

$\text{Effective Leverage} = \frac{1}{\text{Position Margin Ratio}}$

Socialized Losses Threshold Configuration

The bad debt thresholds that determine when to use socialized losses vs. ADL are configurable.

If bad_debt > max(M, open_interest × mark_price x α):
    Trigger ADL
Else:
    Use Socialized Losses

Verification Process

To verify ADL execution was proper:

• Query on-chain state at the block height of ADL execution.

• Reconstruct all position states (size, entry price, unrealized PnL, leverage).

• Apply the documented ranking algorithm.

• Compare the positions selected for ADL against the reconstructed ranking.

• Confirm the selected positions match the top-ranked positions for the required bad debt coverage.