How to fulfill margin requirements in Blockchains, which are slow in comparison to centralized exchanges?

In derivatives trading, like for futures or options, we are dealing with some leverage. The leverage trading is very important thus it allows for higher profit having higher risk. It means that if e.g. underlying instrument rise 10%, so having leverage 5, the future on this underlying is up 50%. As it is for profit, the same values arise for risk, means it’s magnitude is 5.

When the leverage appears, the problem arise how to clear the parties, which are in a trade. Clearing is the way of managing margins in order to, both buyer and seller, are payable. In standard situation when we simplify that it is only one buyer and one seller, one entity is losing and second earning. This is because they are on opposite sides of a position. In the case of 1 leverage, there is no problem with clearing thus it is not possible for prices to go below zero and position never gets negative profit.

The problem with possible negative profit is appearing for leverage trading. E.g. if we bought future, which is traded with leverage 5, and underlying is down 25%, than we not only lose all the margin and equity, but also gain loses on the level of 100% — 5 * 25% = -25% of initial margin. Now we have the problem that buyer is making negative profit, which is not covered and seller in this time making the positive profit, which is only virtual, because he does not got money from buyer. No one will trade on exchange, if fair earned profit cannot be withdraw.

25% in short time for cryptocurrency trading is not so unusual, so one should resolve this issue universally.

In centralized exchanges it is rather simple. The solution for such a situation is speed. In the case of large price movements, the exchange very fast (in milliseconds) close positions, which are near margin calls. Margin call is the situation, when negative profit from position is equal, or over margin, which is locked to the position.

Blockchains and inbuilt in them decentralized exchanges are rather slow in comparison to centralized ones. Blockchains operate in seconds rather, not in milliseconds and can have problems to cope with rapid acting for larger price changes.

What can be the solution?

One can make the insurance reserve. In the case of some negative profits, which are not willing to be covered by users, are just covered by reserve. The insurance reserve should be generated from transaction fees, firstly filled by exchange operators.

The exchange operator can also insure the operating risk by creating instrument (put option) and buy it on its own exchange.

The exchange also may have larger transaction fees for new users. New users have to cover his value to insurance reserve and after they reputation is increased the fees will diminish.

Regarding reputation, we proposed some general solution on that we called it Proof-Of-Reputation (PoR). The description can be found here. PoR is the kind of work that have to be done in order to proof that we are fair playing. In the case above when we make negative profit on leverage trading, it will be not in our benefit not to cover lose, thus we can lose our reputation, on which we work hard😊