Perpetuals and Margin

Leverage and Margin Schedule in USDT Perpetuals On Arkham Exchange, users cannot directly specify the maximum leverage they wish to use. Instead, the leverage is dynamic and determined by a Margin Schedule, which adjusts margin requirements based on position size. As the position size increases, the required margin also increases, reducing the effective leverage.

The margin schedule applies progressively higher initial margin rates for larger positions to ensure that risk is managed as position sizes grow.

How Margin Schedule Works

Margin Schedule defines position bands with corresponding initial margin rates and maintenance margin rates. The maintenance margin rate is set at sixty percent (60%) of the initial margin rate, and the effective leverage is determined based on the initial margin rate.

• The initial margin rate is the percentage of your position size that must be held as collateral to open a position.’

• The maintenance margin rate is sixty percent (60%) of the initial margin, representing the collateral required to maintain the position and avoid partial liquidation of the position, as described below.

• The liquidation margin rate is forty percent (40%) of the initial margin, representing the margin required to prevent the liquidation of the entire margin and the sale of the position to an LSP, as described below.

The margin schedule applicable to each underlying asset’s perpetuals contract can be found by clicking on the “margin” button on the right portion of the screen displayed for that contract.

Example of Dynamic Leverage

Let’s walk through an example

1. Position 1: 800,000 USDT long on BTC/USDT.

   • Initial Margin Rate: 2%
   • Initial Margin: 2% of 800,000 USDT = 16,000 USDT.
   • Maintenance Margin: 1.2% of 800,000 USDT = 9,600 USDT.
   • Effective Leverage: 50x.

2. Position 2: 3,000,000 USDT short on ETH/USDT.

   • Initial Margin Rate: 5%
   • Initial Margin: 5% of 3,000,000 USDT = 150,000 USDT.
   • Maintenance Margin: 3% of 3,000,000 USDT = 90,000 USDT.
   • Effective Leverage: 20x.

In this example, Position 1 uses higher leverage because it's in a smaller band with a lower margin requirement (2%). Position 2 has a larger size and thus requires more collateral (5%), leading to lower leverage.

How Margin Netting and Unrealized PnL Work Under This Model

When a subaccount holds multiple positions, margin netting combines the margin requirements of all open positions and offsets them using the net unrealized profit and loss (PnL) across positions.

Example of Multiple Positions with Margin Netting

Assume the trader holds two positions:

1. Position 1:
   • Long BTC/USDT.
   • Position size: 1,500,000 USDT.
   • Initial Margin Rate: 4%.
   • Initial Margin: 4% of 1,500,000 = 60,000 USDT.
   • Maintenance Margin: 2.4% of 1,500,000 = 36,000 USDT.
   • Unrealized PnL: +50,000 USDT (the position is in profit).
2. Position 2:
   • Short ETH/USDT.
   • Position size: 3,500,000 USDT.
   • Initial Margin Rate: 5%.
   • Initial Margin: 5% of 3,500,000 = 175,000 USDT.
   • Maintenance Margin: 3% of 3,500,000 = 105,000 USDT.
   • Unrealized PnL: -30,000 USDT (the position is in a loss).

Netting the Margin Requirements:

• Total Initial Margin: 60,000 USDT (Position 1) + 175,000 USDT (Position 2) = 235,000 USDT.
• Unrealized PnL offset: The net unrealized PnL is +20,000 USDT (50,000 USDT from Position 1 minus 30,000 USDT from Position 2).
• Effective margin requirement: After netting the unrealized PnL, the effective initial margin requirement becomes:
  • 235,000 USDT - 20,000 USDT = 215,000 USDT.

This means the trader only needs 215,000 USDT in margin to support both positions, as the profit from the BTC/USDT position offsets the losses from the ETH/USDT position, reducing the overall margin requirement and the risk of liquidation.

Impact of Margin Schedules on Risk Management

• Larger positions require more margin: As your position size increases, the margin requirement also increases, reducing the effective leverage.
• Smaller positions offer higher leverage: Traders with smaller positions can use higher leverage because the margin requirements are lower. However, higher leverage also increases the potential risk.
• Unrealized PnL reduces risk: The unrealized profit from one position can offset the losses of another, reducing the overall margin requirement and helping to avoid liquidation.

Key Takeaways

• Dynamic leverage is applied automatically based on the size of your position, with smaller positions allowing higher leverage and larger positions requiring more margin.
• Margin netting allows unrealized PnL from one position to offset the margin requirement for another, reducing the risk of liquidation.
• Monitoring positions is important because while unrealized profit can lower margin requirements, market volatility can quickly shift your net PnL, increasing the risk of liquidation.

Funding Rates Overview

• Sampling Interval: Every second
• Funding Interval: Every hour
• Calculation: Funding rate is calculated based on the difference between the perpetual futures price and the index (spot) price, sampled every second
• Min/Max Values: Funding rate is capped between -0.25% and 0.25%.
• Transfer of Funding: Funding payments are transferred between traders once every hour

Funding Rate Calculation The funding rate is derived from the price difference between the perpetual futures contract price and the index price. This difference is sampled every second over the course of an hour.

The formula for the funding rate at any given second is as follows:

Where:

• perpPrice_t: The price of the perpetual futures contract at time t.
• indexPrice_t: The index price (or spot price) of the underlying asset at time t. The index price is a weighted average of the spot prices of the underlying asset on select well-known centralized exchanges.

The difference is divided by the index price to express it as a percentage.

Hourly Funding Rate

The hourly funding rate is computed as the average of the second-by-second funding rates over the entire hour.

Where: ( n ) is the total number of seconds in an hour (3600 seconds).

This average captures the typical difference between the perpetual futures price and the index price over the funding interval.

Funding Payment

The funding payment is the actual amount exchanged between long and short position holders, based on the trader’s notional position size.

Funding Payment= Position Size × Mark Price × Hourly Funding Rate

• Long Position Holders: If the hourly funding rate is positive, long position holders will pay short position holders.
• Short Position Holders: If the hourly funding rate is negative, short position holders will pay long position holders.

Example

Suppose that the perpetual futures price for Bitcoin over an hour is consistently higher than the index price.

• Average perpetual futures price (perpPrice) = $30,500
  • Average index price (indexPrice) = $30,000

Using the formula for the hourly funding rate:

A trader with a long position of $100,000 notional value would then calculate their funding payment as follows:

Funding Payment = 100,000×0.0167=1,670

Since the funding rate is positive, the long position holder pays $1,670 to the short position holder.

Liquidations

Below Maintenance Margin and Liquidation Process

When trading USDT perpetuals, it’s crucial to maintain sufficient margin to avoid liquidation. If your portfolio falls below required margin thresholds, the exchange has a structured liquidation process involving partial liquidation, Liquidity Support Providers (LSPs), the insurance fund, and automatic deleveraging (ADL) to manage risk effectively.

What Happens When a Subaccount Falls Below Maintenance Margin?

If the margin in your subaccount drops below the maintenance margin (sixty percent (60%) of the initial margin), liquidation is triggered. The exchange will first attempt to partially liquidate your position to prevent further losses by initiating sell orders. If your subaccount falls below the liquidation margin (forty percent (40%) of the initial margin**)**, the exchange will attempt to close your positions through the Liquidity Support Provider (LSP) program, described below. If there isn’t sufficient liquidity, the exchange will draw on its insurance fund to cover any shortfall. As a last resort, automatic deleveraging (ADL) is used to close out positions against opposing traders.

The Liquidation Process

1. Partial Liquidation

When a subaccount falls below the maintenance margin but above the liquidation margin, the exchange will initiate automatic sell orders that will partially liquidate the position to prevent further losses.

1. Liquidity Support Provider (LSP) Program

When a subaccount falls below the liquidation margin, the exchange first attempts to liquidate the position by passing it to participants in the Liquidity Support Provider (LSP) program. LSPs are professional market participants (such as liquidity providers, hedge funds, or proprietary traders) who agree to absorb liquidated positions in exchange for favorable pricing and liquidity incentives.

• Role of LSPs: LSPs provide liquidity by taking over liquidated positions at a negotiated price, helping to minimize market impact.
• LSP Participation: Positions are transferred to LSPs in chunks, and they take over the risk, thus preventing a forced sale at unfavorable market prices. This step helps ensure that large liquidations do not directly impact the market price or cause significant slippage.
• Liquidation at Mark Price + 1% Spread: When a liquidation occurs, LSP participants are allowed to purchase the liquidated position at the Mark Price plus a 1% spread. This ensures that liquidity providers are fairly compensated for taking on liquidated positions, which may carry higher risk in turbulent market conditions.

1. Exchange Insurance Fund

Arkham maintains an Insurance Fund to safeguard traders and the overall ecosystem from extreme market events, particularly during liquidations. The insurance fund is funded by two sources: 1 - any surpluses resulting from the liquidation process described in this section (including through both the LSP Program and ADL, described below), and 2 - contributions from Arkham.¹ Here's how the Insurance Fund ensures the protection of both traders and LSP participants:

• Covering Losses: In the event that a liquidation results in a negative balance or insufficient funds to cover the full position, the Insurance Fund is used to make up the difference, ensuring that LSP participants receive the liquidated positions at Mark Price + 1%, even if the liquidated trader's account balance is inadequate.
• Fair Pricing for LSP: The 1% spread above the Mark Price acts as a buffer, offering an incentive to LSP participants and reducing their risk. The Insurance Fund guarantees that the exchange is able to honor this spread, maintaining fairness in the liquidation process.

By ensuring that LSP participants are compensated with a mark price plus 1% spread and using the Insurance Fund to cover potential shortfalls, Arkham promotes a healthy liquidity environment while protecting traders from excessive loss exposure.

1. Automatic Deleveraging (ADL)

If LSP program participants can't fully cover the liquidated position, the exchange resorts to automatic deleveraging (ADL). In ADL, the system automatically closes out positions by matching them with opposing open positions held by other traders on the platform.

• How ADL Works: The exchange looks for opposing positions (e.g., a long position matched against a short position) held by other participants. The positions are closed out against each other to bring the account back into compliance with the margin requirements.
• Impact on Other Traders: Traders with high leverage and profits are prioritized for ADL matching, meaning their positions might be automatically reduced or closed to balance the risk on the exchange.

Example

• Trader’s Initial Position:

  1. Trader A holds a long position of 10 BTCP in a perpetual contract with an entry price of $30,000.
  2. Liquidation Margin Requirement: 5% of the total position value, that requires a collateral of $15,000.

• Market Movement:

  1. The price of BTC perpetual drops to $28,000.

  2. Trader A’s equity is now ![][https://arkm.com/legal/image4.png]

  3. Liquidation margin required:

     5% of 270,000=13,5005% of 270,000=13,500

  4. Since Trader A’s equity is below the required liquidation margin, their subaccount is passed on to liquidation engine.

Liquidation Process

Step 1: Attempt to Liquidate via LSPs

Liquidation Trigger:

• Since Trader A’s equity is below the required liquidation margin, their subaccount gets liquidated.

  • The exchange attempts to pass Trader A’s position to LSP participants. The BTC price is $28,000, and they take it on at Mark Price - 1% Spread:

    LSP Purchase Price=28,000−(28,000×0.01)=27,720

  LSP Involvement:

  • The exchange sells 5 BTC to LSPs at $27,720 per BTC:

  Value of Liquidated Position to LSP=5 BTC×27,720=138,600

  Insurance Fund Usage:

  Shortfall=138,600+5BTC×28,000+15,000−300,000=−6,400

  • The Insurance Fund covers this shortfall so that LSPs receive the liquidated positions at the agreed price, ensuring no losses occur for them despite Trader A's account deficiency.

Step 2: Remaining Position and ADL

Remaining Position:

• Trader A now has 5 BTC remaining which will be deleveraged

  Automatic Deleveraging (ADL):

  • Suppose another trader, Trader B, has a short position of 10 BTC at $28,000.
  • The exchange identifies Trader B’s short position to match it against Trader A’s liquidated position.
  • Since Trader B has a profitable short position, the exchange will deleverage 5 BTC of their short position at mark price of **$28,000** realising a PnL of 5 \*$2000 = $10,000.

  Closing Positions:

  • Trader B’s position is closed out for 5 BTC, while Trader A’s long position is effectively liquidated.
  • The remaining short position for Trader B becomes 5 BTC.

Summary of Outcomes

• Trader A:
  • Had their 10 BTC long position liquidated.
  • Resulting shortfall of $6,400 was covered by the Insurance Fund.
• Liquidity Support Providers:
  • Acquired 5 BTC at $27,720, absorbing some risk but benefiting from the premium.
• Trader B:
  • Partially closed their 5 BTC short position, gaining $10,000 profit from the market movement and helping to balance risk across the exchange.

Key Takeaways

1. LSPs facilitate smoother liquidations by absorbing positions and maintaining market stability, which helps prevent a rapid decline in price due to forced sales.
2. The Insurance Fund acts as a safety net, ensuring LSPs and the exchange can operate without incurring losses due to trader defaults.
3. Automatic Deleveraging (ADL) provides a mechanism to manage risk and maintain balance by matching positions across different traders.

This example illustrates how a perpetual contract liquidation works in a practical scenario, showing how different mechanisms come together to manage risk and maintain a stable trading environment.

Impact on Traders from Liquidation and ADL

LSP Program and Insurance Fund: These mechanisms are designed to minimize the impact of liquidation on the market and ensure traders’ positions are closed without significant losses beyond the maintenance margin. Automatic Deleveraging (ADL): Traders with high leverage and high profits may see their positions automatically reduced or closed as part of the ADL process. This ensures that the exchange maintains risk management, but it can affect traders’ open positions unexpectedly. As noted above, ADL only occurs when the LSP process fails to liquidate the entire position. Monitoring Margin Levels: To avoid partial or complete liquidation, traders should closely monitor their positions and maintain sufficient collateral. If your position falls below the maintenance or liquidation margin, the liquidation process will start, and you may lose your position partially or entirely.

The liquidation process ensures that the exchange maintains stability and protects traders and the market from sudden, large-scale liquidations.

Margin Schedules Margin schedules are used to determine the margin requirements for a given position size. Each perpetual contract trading pair has one of the below margin schedules associated with it. Each margin schedule defines a series of bands, where each band has a position size range, a maximum leverage, an initial margin rate and a rebate. The initial margin requirement is calculated as the position size multiplied by the initial margin rate minus the rebate. The rebate is provided so that there is no discontinuity in the margin requirement when moving between bands.

Note that the margin requirements within the schedule are applied progressively, meaning that the initial margin rate only applies to the portion of a position that is within a given Position Size Band. For example, a 2 million dollar position in Schedule A below would have the initial margin rate of 2% apply to the first million within the position and a 4% within the second million. Thus, the initial margin rate for the entire position would be 3%.

Margin Schedule A

Margin Schedule B

Margin Schedule C

Margin Schedule D

Margin Schedule E

Margin Schedule F

Margin Schedule G

Footnotes

1. Surpluses may result if the closing price at which a liquidation is executed is better than the bankruptcy price, or the price at which the losses equal the deposited margin at the time of the liquidation. ↩