⁉️Risks

Liquidity Buffer and trading fees minimize the directional exposure risk for LPs.

As discussed in the Ostium Trading Engine section, fees attempt to minimize OI Imbalance, in order to maintain delta neutrality. However, if a high OI Imbalance and volatility periods happen simultaneously, this can result in directional exposure for LPs*.

Directional Exposure Risk

Directional exposure risk occurs when LPs are exposed to price changes in the underlying market. Our understanding of this risk is that 1) OI Imbalance creates the possibility of 2) price movements (volatility) driving uncertainty to LP returns*.

The following Volatility-OI Imbalance matrix illustrates how directional exposure risk changes accordingly:

[Directional Exposure]	Low Volatility	High Volatility
Low OI Imbalance	low	medium
High OI Imbalance	medium	high

The Imbalance Score is a metric developed by Ostium to measure the current overall directional exposure risk experienced by the protocol.

*assuming the Liquidity Buffer is empty

Mitigation

Mitigating the directional exposure risk is fundamental to increasing the protocol's robustness. Ostium minimizes LP exposure through:

• Liquidity Buffer: first settlement layer for profitable trade and supports the directional exposure risk, unless the Buffer is depleted;

• Trading Fees: which have two purposes: 1) reward LPs for putting their funds at risk in service of protocol liquidity, with the possibility of being exposed to directional risk, and 2) drive the protocol towards equilibrium (closing the OI Imbalance or charging more in periods of high volatility).

Minimizing risks for LPs and traders is at the core of Ostium's protocol design.

Monitoring & Improvements

Chaos Labs will actively monitor metrics assessing the protocol's variable directional exposure risk (e.g. Imbalance Score), and make parameter recommendations as needed to optimize risk mitigation. Their team works carefully in concert with the Ostium protocol to ensure this information leads to improvements in both user experience and risk reduction, pushing the protocol towards greater safety and robustness.