Price Impact Function

The first of the two delta neutrality algorithmic mechanisms is the Price Impact function. The price impact function influences the price of the futures contract, which occurs at the time of any futures contract transaction.

The price impact function encourages market neutrality by offering price discounts for traders to take trades that reduce the market skew and premiums for traders who increase the market skew. When there’s a long skew, where there are more traders with long positions than short positions, traders going short will earn a discount on the fill price of their trade based on how imbalanced the skew is. A larger skew will result in a larger premium or discount. If the same trader executes a long trade when there is a long skew, the trader will pay a premium on their fill price. Conversely, when there’s a short skew, traders going long receive a discount, and those going short pay a premium. This mechanism rewards traders to take positions that help reduce the skew and balance the market, promoting stability and reducing risk for stakers.

The Price Impact function is the first layer of incentives that helps protect stakers by ensuring that there are multiple structures that keep markets delta-neutral for liquidity providers. The price impact function mechanism actually creates a high-frequency rebalancing incentive where delta-neutral arbitrage can take place, and places soft limits on the maximum exposure held by the debt pool by storing premiums from takers, who are increasing the skew, and distributing them to makers, who are decreasing the skew. This mechanism reduces the likelihood of non-neutral markets and all of this is algorithmically driven and is achieved without needing explicit restrictive open interest limits and mitigating challenges related to decentralized oracle latency.

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