🏦Overview

The Shared Liquidity Layer (SLL) is composed of a Liquidity Buffer and an LP Market Making Vault. This minimizes the set of circumstances under which LPs extend direct liquidity to traders.

The Shared Liquidity Layer (SLL) is the protocol structure responsible for aggregating liquidity and settling trades, and contains two distinct components:

• Liquidity Buffer: settlement layer for trader PnL, accumulating value during periods of net trader losses and shrinking during periods of sustained trader gains. Does not accumulate trading fees and cannot be deposited into directly or withdrawn from by LPs;

• Market Making Vault: settlement in the event the Liquidity Buffer is depleted. LPs deposit capital into the Market Making Vault and are rewarded for the risk they take on of potentially needing to act as counterparties with liquidation rewards and a portion of trading fees.

Ostium is designed not as central limit orderbook, which relies on order matching and requires an immediate seller for every buyer, but rather as a virtual pool-based DEX able to sustain imbalances in Open Interest, the net delta risk of which is taken on by the Shared Liquidity Layer. The fee design seeks to mitigate both the magnitude and frequency of these imbalances to minimize exposure risk for the vault. Market Making Vault depositors take on the potential risk of delta exposure, including loss resulting from sustained trader gains, when depositing on Ostium.

The Liquidity Buffer is primarily funded by negative PnL trades and serves as the first line of settlement for positive PnL trades, while the LP Market Making Vault acts as a backup.

Liquidity Buffer and LP Market Making Vault

Given our design, you may be asking yourself: Why does Ostium's SLL have two different sub-structures instead of just one?

To begin, let's consider the standard way pool-based perpetuals protocols structure LP rewards and trader counterparty risk. Generally, LPs benefit from and bet directly on trader losses. This leads to an adversarial relationship between traders and LPs, who stand to benefit most from traders losing money.

However, by dividing the vault into two isolated structures (Liquidity Buffer and LP Market Making Vault, or "MMV") and strategically defining fee flows, Ostium is able to shift fund distribution such that LPs – who can only deposit and withdraw funds into the MMV – benefit primarily from volume and Open Interest growth, rather than trader losses. The Liquidity Buffer is designed to be able to absorb trader PnL in the majority of cases, minimizing APY volatility for MMV LPs in the event of sustained trader gains. This reduces the adversarial nature of the relationship between LPs and traders and aligns interests towards overall protocol growth.

LPs are thus not always traders' immediate counterparties but rather extend maker liquidity if and when the buffer is unable to. LPs in return are rewarded with liquidation rewards and trading fees.

To summarize, Ostium's dual vault structure is designed to:

• Shift the adversarial relationship between traders and LPs to a positive-sum one, whereby LPs benefit primarily from protocol volume growth, not trader losses;

• Reduce APY variability, with the Liquidity Buffer acting as the first and primary settlement layer;

• Remain simple and user-friendly, abstracting complexity with only one pool – the LP Market Making Vault – to deposit into.

Vault interactions and fee distribution

So how does this work, practically?

At a high level, the Liquidity Buffer accrues trader PnL, whether positive or negative, and volatility fee, while the LP Market Making Vault accrues fees (liquidation reward and 50% of the opening fee) and acts as settlement for trader PnL if and only if (IFF) the Liquidity Buffer is depleted. Over time, assuming small net trader losses, the Liquidity Buffer grows in value, enabling more rapid expansion of Open Interest caps due to Buffer capital's stickiness and reducing APY variability for LPs, whose risk of needing to act as a trader counterparty goes down.

The following diagram provides an overview of capital flows:

Let's break down the capital flows for each trade lifecycle step:

1. Opening trades: a % of the initial collateral is reserved for the protocol opening fee and evenly (50/50) distributed between Market Making Vault (where LPs deposit) and Protocol Revenue;

2. Holding trades: volatility fee is accrued from period to period on the open positions and goes directly to the Liquidity Buffer;

3. Closing trades:

   1. Profit (positive PnL):

      1. Liquidity Buffer > 0: Liquidity Buffer settles trades;

      2. Liquidity Buffer = 0: LP MM Vault settles trades, if and only if the Liquidity Buffer is depleted (further details here);

   2. Loss (negative PnL):

      1. Not Liquidated: Liquidity Buffer receives traders losses;

      2. Liquidation: 90% of initial collateral (traders loss) goes to the Liquidity Buffer and the remaining 10% goes to the LP MM Vault (liquidation reward).