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Risk Mitigation

Supporting a wide array of markets to trade comes with its risks.
Markets, in particular those with small caps and less liquidity, are prone to insider advantage, price manipulation, and other hazards that can be detrimental to liquidity providers. CAP takes a Risk-Based Approach (RBA) at several levels to preserve a fair trading environment for all participants.

Market-Based

A market's risk increases if:
  • it is thinly traded (illiquid);
  • has a smaller market cap;
  • has a token or share supply controlled by just a few whales; and/or
  • has consistently high volatility.
Since CAP's liquidity pool is shared across all markets, it is paramount to limit risk on a per-market basis to prevent contagion. Market risk mitigation measures are listed below.

Maximum Open Interest

Once current open interest exceeds this value, orders are no longer accepted on this market.
This setting is lower for higher risk markets.

Maximum Leverage

Users trading with an information or insider advantage should provide more real collateral (margin) when placing trades, increasing their risk.
This setting is lower for higher risk markets.

Fee

Users trading with an information or insider advantage should pay more to trade, tempering improper profits over time.
This setting is higher for higher risk markets.

Funding Factor (FF)

The FF is the yearly rate at which longs (or shorts) pay shorts (or longs) if open interest were completely skewed toward longs (or shorts).
Users trading with an information or insider advantage will skew open interest toward their directional bias. Therefore, this setting is higher for higher risk markets.

Liquidation Threshold

A position can be liquidated once its loss reaches this threshold, set on a per-market basis. For less liquid and more volatile markets, positions have to be liquidated before reaching maximum loss (equal to their collateral value) due to rapid price changes.
Therefore, this setting is lower for higher risk markets.

Reduce-Only or Limit-Only Mode

In extreme scenarios involving data errors or exploits, markets can be set to accept only reduce-only or limit orders.

Pool-Based

CAP liquidity pools also come with their own set of risk mitigation measures.

Dynamic Deposit/Withdraw Costs

Liquidity providers who want to deposit or withdraw from the pool will pay a tax if the pool buffer and total trader unrealized profit or losses are in their favor. This is to maintain expected value neutrality and prevent liquidity sniping, like depositing right before a large trader loss occurs to scoop up the loss.
A Pool Deposit Cost (PDC) applies if total trader unrealized P/L minus the buffer balance is < 0. Given an Amount to deposit:
PDC=BufferBalanceUPLPoolBalance+AmountPDC = \frac{BufferBalance - UPL}{PoolBalance+ Amount}
Similarly, a Pool Withdrawal Cost (PWC) applies if total trader unrealized P/L minus the buffer balance is > 0. Given an Amount to withdraw:
PWC=UPLBufferBalancePoolBalanceAmountPWC = \frac{UPL - BufferBalance}{PoolBalance- Amount}

Maximum Drawdown

A pool's maximum drawdown is set per-asset as a percentage of the pool's balance. It measures the net loss of a pool over time, so you can think of it as a time-weighted drawdown.
It is calculated in real-time and amortized every hour by 4.16%, so the impact of a trader's profit-taking disappears after 24 hours.
For example, a trader cannot close an unrealized profit of $1M all at once on a pool with a maximum PPL of $500K. They would need to close this relatively high profit over time, minimizing impact on the pool.
The maximum drawdown exists to mitigate information advantage and insider risk across markets.
This setting is generally maintained at around 12% per pool.

Pool Buffer

Since anyone can trade and anyone can participate in the pools, a risk arises where a user can both make trades and provide liquidity to get back some of their trading losses.
For example, a user can simultaneously open large long and short positions on a given market (using different wallets). The user can later close their winning position, taking a profit, then deposit in the pool and close their losing position, redeeming some of their losses.
To mitigate this risk scenario, CAP pools have a buffer.
When a trader makes a loss, it is sent to the buffer which then streams it to the pool at an adjustable rate, currently 100% in around 30 minutes. The buffer stream is sent in equal share to all pool participants.
When a trader makes a win, it is first paid from the buffer, then from the pool if the buffer is not enough to cover it.

User-Based

As a DeFi protocol, CAP is openly accessible, making user-based risk mitigation ineffective since users can create new wallets at will. CAP implements some risk reduction measures associated with users with already open positions, such as curbing profits that result from price data errors.