Exchange Risks

Centralized exchanges may become insolvent due to poor financial management, hack-related losses, or external market events.

Examples include the collapse of FTX and Mt. Gox, which led to significant losses for users whose funds were trapped.

Exchanges may experience outages, degraded performance, or data inaccuracies during periods of high market volatility, preventing trades or liquidations from being executed in a timely manner.

Exchanges are subject to regulatory actions, including license revocations, trading restrictions, or asset freezes, which can impact users' ability to access funds.

For example, regional bans on certain exchanges or assets may prevent the protocol from maintaining positions or withdrawing collateral.

Funds deposited directly on exchanges remain under custodial control of the exchange, leaving them vulnerable to mismanagement, fraud, or loss in the event of exchange failure.

Thin order books or a sudden drop in exchange liquidity can create slippage and impact trade execution, especially for large positions.

Decentralized exchanges rely on smart contracts, which may be exploited, malfunction, or experience downtime, leading to losses or the inability to execute trades.

• Protocol assets are not fully deposited on centralized exchanges. Instead, off-exchange settlement providers (e.g., Copper's Clearloop, CEFFU's MirrorX) are used to custody assets and minimize direct exposure to exchange custodial risks.
• These providers facilitate non-custodial trading workflows, allowing the protocol to execute trades without transferring full ownership of the collateral to the exchange.

• The protocol spreads trading activity across multiple exchanges to reduce reliance on any single venue.
• Strict concentration limits are enforced to ensure that no single exchange exceeds a predefined percentage of the protocol's trading activity or collateral exposure.
• Exchanges are evaluated based on their financial health, liquidity, regulatory compliance, and operational reliability.

• The protocol continuously monitors exchange solvency, operational performance, and market conditions.
• Factors monitored include exchange reserve transparency and proof-of-reserves data (where available), trade execution performance and latency, and regulatory developments affecting specific exchanges or jurisdictions.
• If an exchange shows signs of trouble (e.g., withdrawal delays, regulatory scrutiny, or significant reserve outflows), the protocol reduces or closes positions on that exchange.

• Unrealized profits and losses (PnL) are settled frequently to prevent large balances from accumulating on any one exchange.
• Settlement cycles are determined based on the operational characteristics of each exchange (e.g., daily settlement on Binance and Deribit, hourly settlements on Bybit).

• In the event of an exchange failure, the protocol employs failover mechanisms to reallocate positions and maintain hedging activities.
• Failover actions include transitioning open positions to alternative exchanges with sufficient liquidity, using alternative instruments such as deliverable futures or decentralized derivatives to maintain hedges, and adjusting portfolio allocations to reduce reliance on derivatives temporarily.

• The protocol conducts regular stress tests to simulate exchange failure scenarios, such as abrupt insolvency of a major exchange, withdrawal freezes or delays, and market-wide liquidity crises.
• Contingency plans are developed based on the results of these tests to ensure the protocol remains operational under adverse conditions.