What Is the Function of an Exchange’s “Insurance Fund” during an Isolation-Induced Liquidation Event?

An exchange's insurance fund acts as a financial buffer to cover losses that occur when a liquidated position cannot be closed out in the market at a price better than its bankruptcy price. In an isolation-induced liquidation, the insurance fund absorbs the deficit, preventing the loss from being passed on to other solvent traders through an auto-deleveraging (ADL) system.