Fortifying Against Scam Wicks and Unfair Liquidations

March 22, 2024

In the labyrinth of decentralized exchanges (Dexes), there looms a common nemesis: scam wicks. These sudden, drastic price movements strike fear into the hearts of traders, leaving them vulnerable to unfair liquidations. While many platforms strive to make users whole after such ordeals, it's imperative, as an industry, to fortify our defenses. At Paradex, we've added several additional safeguards that together make for a really robust liquidation mechanism.

The Crucial Role of a Robust Mark Price

An exchange’s mark price methodology plays a critical role in preventing unfair liquidations and mitigating the risks of scam wicks. Derived from the spot oracle price multiplied by (1 + Funding Rate), Paradex’s mark price serves as the cornerstone for calculating profits and losses, funding, margin requirements, and triggering liquidations. A resilient mark price relies on two key mechanisms:

1. Reliable Spot Oracle Price

It might sound simple, but leveraging a competent Oracle provider is a big part of ensuring that the mark price is resistant to manipulation and attacks. Pyth Network uses a robust price aggregation and averaging mechanism to provide a reliable underlying spot price.

The averaging method is a slot-weighted, inverse confidence-weighted exponential moving average of the aggregate price. Read more about Pyth’s mechanism here.

2. Funding Rate Dampening + Clamping

The mark price also incorporates the difference between the perpetual price and the underlying spot price. This makes funding rates susceptible to large spikes, particularly for illiquid instruments, which in turn can trigger unnecessary liquidations. To prevent spikes there are two additional protections needed:

🔸 Funding Rate Dampening: Paradex calculates funding rates using an exponentially weighted moving average (EWMA) of median implied rates from the best bid, best ask and the last traded price relative to the spot price. As a result of this “smoothing”, the deviation of mark vs spot is much more stable than the deviation of mark vs the last traded price (see chart below)

Mark vs Trade Price SOL

🔸 Funding Rate Clamping: In extreme scenarios, dampening alone is not sufficient! As an additional protection, we enforce funding rate clamping. For example on BTC/ETH pairs, the funding rate is capped at +/-2%, and for other perpetuals, it's limited to +/-5%.

Beyond our robust mark price methodology we have additional tools to help mitigate scam wick risk:

Optimized Insurance Fund Unwind Algo that Minimizes Market Impact

Liquidations on Paradex are performed by our Paradex Insurance Fund Contract, equipped with a sophisticated unwind algorithm designed to close positions from liquidated accounts while minimizing market impact. “Minimizing market impact” is the important bit here. Unlike some other DEXes, the Paradex liquidation process does not involve market orders which can further magnify spikes in times of price volatility and illiquidity.  

Price Band Protection for Market Orders

During times of stress however, it isn’t just the insurance fund dumping a position (via market orders) that you have to protect against. Other traders caught offside on a price move typically start market dumping so there is a tremendous amount of price pressure coming from traders trying to protect their position.

Paradex protects the orderbook from the impact of aggressive orders using price band conditions:

🔸 5% for BTC/ETH
🔸 10% for other perpetuals

This means an aggressive order (including market orders) cannot be filled beyond 5% from the mark price which limits its impact on the orderbook.

As a result, the Paradex price for a perp does not exhibit the same extreme price wicks observed on other exchanges during a volatile market.

Let’s dive into an example of this in the real world by looking the $SOL market on 28 Feb around 17:30 UTC on Hyperliquid / Binance / Paradex.

Hyperliquid SOL-USD (price went down to $90)

Binance SOLUSDT (price went down to $104.80)

Paradex SOL-USD-PERP (price went down to 106.30)

Paradex is deeply committed to building fair and orderly markets in crypto. Our approach to fair liquidations is just one of many ideas we have for improving the crypto markets. Stay tuned for further updates!

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