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2) NOT FINANCIAL ADVICE, NOT LEGAL ADVICE

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3) Let's say that you have a margin trading protocol which allows cross-margin between a bunch of different assets. Your algorithm is "require 30% initial margin and 20% maintenance margin"--i.e. allow ~3x leverage, and margin call accounts if they get up to 5x leverage.

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4) You have an 'oracle' which reports the price of the assets, and your risk engine--the thing that calculates users' margin--uses prices from that oracle. One asset--say XYZ--has a price of roughly $0.40 according to the oracle. A user--Alice--has $200m XYZ and -$25m USD.

5) Alice: 500m XYZ ~ $200m -25m USD = -$25m net value ~ $175m margin ~ 87.5% how much should the risk engine allow Alice to withdraw?

12:15 PM · Oct 12, 2022Twitter Web App

6) A naïve answer would be "well if you require 30% margin then Alice can withdraw up to $115m; at that point her account would be: 500m XYZ ~ $200m -140m USD = -$140m net value ~ $60m margin ~ 30%"

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7) But there's a picture of a mango over The Oracle's face. So, obviously, XYZ is actually MNGO, and MNGO isn't really worth $0.40; it's worth around $0.04. Alice's real account value is, roughly: 500m XYZ ~ $20m -25m USD = -$25m net value ~ -$5m margin < 0 It's already gone.

8) But for a brief period, someone (almost certainly Alice) bought enough MNGO that it did trade for $0.40, and before people could get in to sell and return it to a more reasonable price, the risk engine had already allowed Alice to withdraw $100m from Mango Markets.

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9) So, what went wrong? Did the oracle fuck up? I mean, not really. Or, rather, it depends on what the specs of the oracle were. The oracle accurate reported the current price of MNGO. It's just that the 'current price' wasn't really anything close to the 'fair price'.

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10) What should you really do? Well, let's look at what FTX does, and why *it* didn't have any risk engine issues.

Order Limits and Price Bands

11) First, FTX has EWMA price bands. What this means is, roughly, that FTX consumes raw price feeds. But, before feeding that into its risk engine, it bounds those price feeds so that they can't move more than ~20% over a 5 minute period.

help.ftx.com

Order Limits Users can’t send orders that would move the price more than 2% (for futures markets) or 25% (for spot markets) through opposite side of the book. Orders too far through the book get ...

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12) The reason, basically, is: b) If an asset's price moves 3x in 1 minute, it's decently likely to be bad data, or a temporary wick, or something like that b) If the asset's price stays there for 5 hours, that new price is likely the true economic price

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13) FTX's MNGO index price moved--there should be *some* update--but much less than others because of those EWMA price bands. In particular, while FTX's index topped out at a ~100% increase, on some exchanges the move (temporarily!) hit a +900% increase (!!!).

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14) Second, FTX uses 'IMF Factors'. The larger your position, the greater % margin we charge. For MNGO, the margin we charge is 0.00025 * sqrt(MNGO tokens). If you wanted to have a 500m MNGO position, FTX would have required, uh, 500%. (Bounded at 'fully funded'.)

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As the terms of service make clear, manipulative behavior is not tolerated on FTX. Any attempts to do so may result in account termination at FTX's sole discretion. Indices Market price: median...

15) The reason, basically, is that large positions--especially in illiquid tokens--can have a lot of impact. So we charge more % margin the greater your position is.

help.ftx.com

Complete Futures Specs

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16) And some positions -- like the one in question -- are large and illiquid enough that the risk engine forces you to fully collateralize a position.

Spot Margin Trading Explainer

17) So even before hitting position limits, the risk engine ensures that the collateral backing a position is sufficient. And what if you try to use something other than dollars as collateral? Well, we haircut it. In some cases, a lot.

help.ftx.com

Overview With spot margin trading, users can trade with leverage and go short on spot markets by borrowing from other users (lenders) on FTX, who are looking to earn yield on their assets. Rates ...

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18) (It's worth noting that this is all referring to FTX International. In addition to all of the above protections, our amendment for FTX US Derivative's margin order would only be for BTC and ETH futures using USD margin. No MNGO, and certainly no MNGO collateral.)

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19) There are a bunch of other risk engine protections and sanity checks, too, which would have caught something like this. So -- back to the oracle. It reports: "MNGO: $0.40" Is it wrong?

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20) Well, it depends on what it's promising. But probably it's just promising to tell you, literally, what MNGO is currently trading at. And, for a brief period, on some exchanges, MNGO was in fact trading at $0.40. The real problem here was using the raw oracle price.

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21) The Oracle tells you everything and nothing--the history and current state of markets. It's the risk engine's job to consume that information, and decide what positions are safe. Sometimes it can't just regurgitate The Oracle. Sometimes it has to make up its own damn mind.

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22) Which doesn't mean that the risk engine needs to be manual. You can create a set of rules for it so that it's conservative, and handles apparent large moves gracefully. That, in the end, is probably the most important thing we do at FTX.

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