Rate Swap Protocol

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Risk Management ​

Essential risk management practices for trading on the Rate Swap Protocol.

Health Factor ​

Your position health determines liquidation risk:

Health = Collateral_Value + Realized_PnL + Unrealized_MTM - Maintenance_Requirement

Where:

  • Collateral_Value: Your deposited quote tokens (e.g., USDC)
  • Realized_PnL: Accumulated funding settlements in your positions
  • Unrealized_MTM: Mark-to-market value of open positions
  • Maintenance_Requirement: Minimum margin based on notional exposure

Status:

  • Healthy: health >= 0
  • Liquidatable: health < 0

Monitoring Health ​

  • Check health factor before and after trades
  • Add collateral if health is declining
  • Reduce position size to improve health
  • Monitor realized PnL accumulation from funding settlements

Margin Requirements ​

Initial Margin ​

Required to open or increase position:

Initial_Margin = |notional| × initial_margin_bps / 10000

Example: 500 bps (5%) means $5,000 initial margin per $100,000 notional.

Maintenance Margin ​

Minimum to avoid liquidation:

Maintenance_Margin = |notional| × maintenance_margin_bps / 10000

Example: 300 bps (3%) means $3,000 maintenance per $100,000 notional.

Margin Floor (Per-Position) ​

The protocol also enforces a minimum margin floor based on rate and time:

R_eff = max(|current_rate|, min_rate_floor)
T_eff = max(time_to_maturity, min_time_floor)
Floor_Margin = |notional| × R_eff × T_eff × multiplier / SECONDS_PER_YEAR

Your effective margin requirement is: max(BPS_Margin, Floor_Margin)

This prevents undercollateralization when rates or time-to-maturity are very small.

Margin Buffer ​

Keep extra collateral above maintenance:

  • Protects against sudden rate moves
  • Provides buffer for adverse funding settlements
  • Reduces liquidation risk

Liquidation ​

Accounting-Only Settlement ​

Before understanding liquidation, it's important to understand how the protocol settles funding:

Key concept: Settlement is purely bookkeeping - no SPL token transfers occur during funding settlement.

When your position is settled:

  1. Your realized_pnl is updated: position.realized_pnl += rate_settlement_delta
  2. The pool's counterparty balance is updated: market.pool_rate_accumulator -= rate_settlement_delta
  3. No tokens move until you explicitly deposit or withdraw

This accounting-only approach means:

  • Funding payments accumulate in your position's realized_pnl
  • Your equity includes both collateral AND accumulated realized PnL
  • Tokens only transfer when you withdraw margin

When Liquidation Occurs ​

Your position is liquidatable when:

  • Health < 0 (after settling funding and computing MTM)
  • Oracle is fresh and settlement is valid

Crank-Only Liquidation Process ​

The protocol uses a crank-only liquidation model:

  1. Anyone can trigger liquidation - it's permissionless
  2. Funding settles (accounting-only) to latest oracle index
  3. Health is computed - must be negative to proceed
  4. Close amount calculated using closed-form approximation:
    K = |health| × WAD / (maintenance_rate - penalty_rate - sign_adjusted_mtm)
  5. Position reduced via AMM at current market rate
  6. Penalty applied (accounting-only):
    • Deducted from victim's position.realized_pnl
    • Credited to pool's market.pool_rate_accumulator
  7. Post-liquidation health verified to be improved and near zero

Important: The liquidator does NOT receive the penalty directly. All penalties go to the pool, benefiting LPs. This is different from traditional liquidation systems where liquidators receive a reward.

Avoiding Liquidation ​

  • Monitor health factor continuously
  • Deposit additional collateral proactively
  • Reduce position size in adverse markets
  • Close positions before they reach liquidation threshold
  • Keep buffer for adverse funding accumulation

Circuit Breakers ​

The protocol has market-level circuit breakers that can affect your trading:

Market Status ​

  • Normal: All trades allowed
  • Closing-Only: Only risk-reducing trades (can only decrease |notional|)
  • Halted: Only liquidations allowed, no trading

When Circuit Breakers Activate ​

Circuit breakers may be triggered when:

  • Oracle data becomes unreliable
  • Extreme market volatility occurs
  • Emergency admin intervention is needed

Impact on Your Positions ​

During Closing-Only mode:

  • You can reduce or close positions
  • You cannot increase position size
  • Liquidations still function normally

During Halted mode:

  • You cannot trade at all
  • Liquidations can still occur
  • Wait for market to reopen

Position Sizing ​

Conservative Approach ​

  • Use 2-3x initial margin (e.g., 10-15% collateral for 5% IM)
  • Limit position size to small % of portfolio
  • Diversify across multiple markets/maturities

Leverage Considerations ​

Higher leverage = higher risk:

  • More sensitive to rate movements
  • Less buffer for adverse funding
  • Faster path to liquidation

DV01 Budgeting ​

Calculate your DV01 exposure:

DV01 = |notional| × T_eff × 0.0001

where:
  T_eff = max(time_to_maturity_years, min_time_floor_years)

Limit total DV01 to a fraction of your capital.

Note: The protocol uses DV01-based liquidity gating. For risk-increasing trades, available liquidity is reduced by a DV01 reserve, so very large trades may see reduced depth.

Risk Caps ​

Open Interest (OI) Caps ​

Each market has a maximum gross open interest:

  • Trades that would exceed the OI cap are rejected
  • Liquidations always succeed (they reduce OI)
  • OI = sum of |notional| across all positions

DV01 Caps ​

Each market has a maximum gross DV01:

  • Risk-increasing trades that would exceed the cap are rejected
  • Limits the market's sensitivity to rate movements

If your trade is rejected due to caps, try:

  • Reducing trade size
  • Waiting for other positions to close
  • Trading on a different market

Rate Risk Management ​

Scenario Analysis ​

Model position P&L under different rate scenarios:

  • Rates up 1%, 2%, 5%
  • Rates down 1%, 2%, 5%
  • Stress scenarios (extreme moves)

Stop Losses ​

Set mental stop-loss levels:

  • Close position if MTM loss exceeds threshold
  • Exit if health factor falls below comfortable level

Time Decay ​

Positions near maturity have different risk:

  • Lower DV01 (less rate sensitivity)
  • Margin floor may dominate margin requirement
  • Consider closing before maturity

Funding Risk ​

Funding Accumulation ​

Under accounting-only settlement:

  • Funding settlements accumulate in position.realized_pnl
  • Adverse funding drains your effective equity
  • Monitor realized_pnl in your positions

Funding Buffer ​

Maintain extra collateral to absorb funding volatility:

  • Estimate potential funding over holding period
  • Keep buffer above expected funding payments

Oracle Risk ​

Staleness ​

  • Stale oracle halts trading and settlements
  • Positions frozen until oracle updates
  • Ensure oracle reliability before large positions

Manipulation ​

  • Oracle manipulation could impact settlement
  • Protocol uses trusted oracle sources
  • Monitor oracle updates for anomalies

Portfolio Risk ​

Diversification ​

  • Spread exposure across multiple markets
  • Different rate indices (funding, borrow, etc.)
  • Different maturities

Correlation ​

  • Some rate indices correlate highly
  • Diversification benefit depends on correlation
  • Monitor cross-market exposure

Maximum Exposure ​

Set limits on:

  • Total notional across all positions
  • Total DV01 budget
  • Maximum % of collateral at risk

Best Practices ​

  1. Start Small: Begin with conservative position sizes
  2. Monitor Continuously: Check health, MTM, realized PnL regularly
  3. Keep Buffer: Maintain collateral well above maintenance margin
  4. Understand Accounting: Know how realized_pnl accumulates
  5. Watch Circuit Breakers: Be aware of market status
  6. Respect Caps: Size trades to fit within OI/DV01 limits
  7. Plan Exits: Know when you'll close positions
  8. Understand Mechanics: Fully grasp funding, MTM, liquidation
  9. Test Scenarios: Model worst-case outcomes before trading
  10. Stay Informed: Track oracle updates and protocol changes

Emergency Procedures ​

If Health is Declining ​

  1. Immediately deposit more collateral, or
  2. Close part of position to reduce margin requirements
  3. Monitor for liquidation threshold

If Liquidation is Imminent ​

  • Close position manually to avoid liquidation penalty
  • Note: Penalty goes to pool, not to a liquidator
  • Withdraw remaining collateral after closing
  • Reassess risk tolerance and position sizing

If Market is Closing-Only ​

  • You can still close or reduce positions
  • Cannot open new positions or increase size
  • Wait for market to return to Normal status

If Market is Halted ​

  • Positions frozen until market reopens
  • Cannot trade, but liquidations can still occur
  • Wait for protocol admin to restore market

If Oracle is Stale ​

  • Positions frozen until oracle updates
  • Cannot trade, withdraw, or settle
  • Wait for oracle authority to update

Next Steps ​

Released under the ISC License.

Rate Swap Protocol Documentation