Risks
Liquidity Buffer and trading fees minimize the directional exposure risk for LPs.
Last updated
Liquidity Buffer and trading fees minimize the directional exposure risk for LPs.
Last updated
As discussed in the Ostium Trading Engine , 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 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
*assuming the Liquidity Buffer is empty
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.
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.