What Is an Insurance Fund in the Context of a Derivatives Exchange and How Is It Used?

An insurance fund is a pool of capital maintained by a derivatives exchange to cover losses incurred when a liquidated position cannot be closed in the market at a price better than its bankruptcy price. In essence, it prevents the exchange from having to "socialize" losses across all profitable traders.

The fund is typically capitalized by fees and any remaining margin from liquidated positions that were closed above the bankruptcy price. If a major stablecoin depeg occurs, the fund is the first line of defense against systemic failure.