Explaining Protocol Parameters and Sharing Development Updates
Community Newsletter #24: October 2023
The most notable events for the Increment community in October included the successful implementation of the timestamp upgrade on zkSync Era (shoutout to the Matter Labs team!) and a proposal to deploy the Increment protocol on Era.
In the spirit of operating autonomous smart contract systems and transparency, let’s dive into the key considerations for determining each set parameter in the ClearingHouse and Vault that is found in the latest Deploy on zkSync Era proposal.
Protocol Parameters
MinMargin is essentially the minimum amount of collateral that traders must maintain in their accounts to avoid liquidation, it is proposed to be set at 3%. It serves as a safety net to protect both the traders and the trading platform from unpayable losses or bad debt. Let's break down the key implications of minMargin:
Capital Efficiency: A higher minMargin reduces the capital efficiency for traders. In simpler terms, it means that traders need to lock up more of their funds as collateral, limiting the amount they can trade with. This restriction can affect their ability to maximize their trading potential.
Risk Mitigation: Conversely, a higher minMargin decreases the risk of a position becoming insolvent due to sudden price changes. When traders are required to maintain more collateral, they are better equipped to weather short-term price fluctuations without getting liquidated.
Maximum Leverage: Higher minMargin also decreases the maximum leverage available to traders. Leverage enables traders to amplify their positions, but a higher minMargin puts a cap on this amplification.
Liquidation Probability: Increasing the minMargin raises the probability of cascading liquidations. This means that more positions are at risk of being liquidated, which can lead to a chain reaction of further liquidations. However, the positive aspect is that it decreases the risk that these liquidations will lead to insolvency.
Next, let's explore the purpose of minMarginAtCreation, it is proposed to be set at 5%. At a low level of abstraction, this parameter serves as a preventive measure, ensuring that newly created positions are not immediately subjected to liquidation. It acts as a safety buffer for traders, safeguarding them from the risk of instant liquidation. As a result, it would be prudent to set minMarginAtCreation somewhat higher than minMargin.
minPositiveOpenNotional exists to ensure that positions are not so small that liquidation becomes economically unviable, it is proposed to be set at 35 USDC. This occurs when the liquidationReward is less than the gas fees required to execute the liquidation. In such cases, liquidators could end up in a situation where they incur a loss due to transaction costs exceeding the liquidation reward.
Thus, striking the right balance with minPositiveOpenNotional is crucial. If it is set too high, there is a risk of excluding smaller traders from participating in the market. Small traders with limited capital may find it challenging to meet this threshold, potentially limiting their involvement in trading activities. On the other hand, if minPositiveOpenNotional is set too low, the liquidationReward becomes unnecessarily high for larger positions. This risks dissuading traders and liquidity providers from opening large positions, due to the possibility of being disproportionately penalized during liquidation.
liquidationReward is a parameter that is meticulously set to ensure that a position, with a size equivalent to or exceeding minPositiveOpenNotional, remains profitable to liquidate. It is proposed to be set at 1.5%. The position’s collateral value is essential to securing the profitability of liquidation, protecting traders and the trading platform alike. A crucial step in this process also involves the calculation of gas costs. Out of this 1.5% liquidation reward, a proposed 30% will be paid to insurance determined by the liquidationRewardInsuranceShare parameter.
insuranceRatio represents the proportion of collateral required to cover potential losses in the event of a liquidation. In essence, it serves as a safety net, ensuring that there is enough collateral to protect users' assets. The higher the insurance ratio, the more capital needs to be locked up in the insurance reserve. A low insurance ratio requires less collateral, making it more cost-effective for the platform. There are trade-offs for each, but it is currently proposed to be set at 10%.
liquidationDiscount, nonUACollSeizureDiscount, and uaDebtSeizureThreshold are parameters related to non-UA collateral (e.g. ETH, etc) which the protocol can support in the future, but at the moment they are out of scope since only USDC is supported. initialTokenMaxMintCap limits the amount of UA that can be minted to 10,000,000, this can be increased once the protocol is more battle tested.
Development Updates
With the timestamp upgrade complete on zkSync, we are full steam ahead on preparing to open source the core protocol repository, working on a multiplier specification for the safety module, and organizing new exciting events for the community that will be released at the same time as launch, some key highlights:
Completing initial peer review of peripheral contracts
Prepping for open sourcing
Formulating math solutions and specifications for multiplier in the safety module
Creating marketing collateral to showcase Increment at launch if the deployment proposal successfully passes
A magical aura glows below and fills the air with a sense of wonder and enchantment, it will be unveiled in due time.
Increment is a decentralized, algorithmic perpetual swaps protocol building on zkSync Era, featuring automatically concentrated liquidity, dynamic fees and parametrizable pools.
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