💦Liquidity Buffer

The Liquidity Buffer is the primary settlement layer for trader PnL. It enables traders to execute trades without an immediate trading counterparty, resulting in OI imbalance & buffer delta exposure.

LPs can not deposit or withdraw from the Buffer.

If the Ostium trading engine is designed to mitigate risk, why does the protocol need a Liquidity Buffer? For two reasons:

• Settle trades: when a trade is closed, the Liquidity Buffer provides capital to profitable trades and accumulates value from trade losses;

• Support traders' directional exposure risk: when the OI Imbalance differs from 0, the Liquidity Buffer buffers this risk (no pun intended), minimizing variability in LP rewards.

Scaling Assets & Facilitating Delta Exposure

While Ostium's fee structure is designed to push the protocol towards equilibrium, the function of the pool is to enable traders to take on directional exposure on an asset, even in the absence of a direct trading counterparty. This is particularly important for scaling to long-tail or low-liquidity assets, which may see periods of few or no traders in a particular direction. To facilitate listing such assets – listing diversity and novelty being core to the protocol's value proposition – Ostium features a shared liquidity model. This pooled liquidity enables the accrual of directional exposure, or Open Interest imbalance, while preserving a buffer of capital to ensure trade settlement.

If the Liquidity Buffer is depleted, the LP Market Making Vault settles trades, acting as a Market Maker to extend liquidity to traders.

There are three possible states of Delta Exposure in the protocol. Considering only one asset, the following protocol agents are active in each state:

1. Only traders: long and short OI is perfectly balanced

2. Traders and Liquidity Buffer: OI imbalance differs from 0

3. Only Liquidity Buffer: either long or short OI is 0

Ideally 1) all trades are perfectly balanced, however, the most common scenario is 2), with some OI Imbalance, where the counterparties to the "skewed" side are those traders on the opposite side (short to a skewed long, and the inverse) and the Liquidity Buffer.

Usage of LP MM Vault

If and only if the Liquidity Buffer gets depleted, the LP MM Vault is used to settle trades. If, for instance, large, highly profitable trades are closed consecutively, there is potential for the Liquidity Buffer to be drained. This event activates temporary utilization of the LP MM Vault to cover potential trader gains.