SPIRE PROTOCOLDefault waterfall
When a participant fails to meet an obligation, Spire Protocol does not race to sell its position into the market. Loss is absorbed in a fixed order.
The order
- Margin of the defaulting participant. Their own collateral goes first.
- Their contribution to the default fund. Still their own money.
- The protocol insurance layer. Capital set aside by the protocol itself.
- The mutualised fund of the other members. Only here does anyone else's money move.
- Auction. The position is auctioned to other clearing members.
The order is fixed in advance. It is not a policy that can be adjusted during a stress event, because a discretionary waterfall is not a waterfall.
The layers, with numbers
| Layer | Source | Size at launch |
|---|---|---|
| 1 | Defaulter's initial margin | 8% to 20% of its notional, by tier |
| 2 | Defaulter's default fund contribution | 15% of its required margin, floor 50,000 USDC |
| 3 | Protocol insurance | 2,500,000 USDC |
| 4 | Mutualised fund | Capped at 2x each member's contribution per event |
| 5 | Auction | The position itself |
Layer 4 is the only one that touches capital belonging to members who did nothing wrong, and it is capped. That cap is the number a member should read before joining, because it is the most that somebody else's failure can cost them in one event.
Worked example
A tier 1 member carrying 10,000,000 of notional stops meeting margin calls, and the position is 6% underwater by the time the cure period expires.
| Step | Amount | Running shortfall |
|---|---|---|
| Loss to cover | 600,000 | 600,000 |
| Layer 1, its margin at 8% | 800,000 | 0 |
The default is absorbed at layer 1 and nothing else moves. No other member is touched, no insurance is drawn, and no auction happens.
Now the same default in a gap, where the position is 14% underwater:
| Step | Amount | Running shortfall |
|---|---|---|
| Loss to cover | 1,400,000 | 1,400,000 |
| Layer 1, margin | 800,000 | 600,000 |
| Layer 2, own fund contribution | 120,000 | 480,000 |
| Layer 3, protocol insurance | 480,000 | 0 |
Still nobody else's money. The mutualised layer is reached only when a single default exhausts 2.5 million of protocol capital after the defaulter's own money is gone.
The timeline
| Event | When |
|---|---|
free goes negative | Margin call issued, curesAt set |
| Cure period | 600s |
| Default declared | Immediately after cure expires |
| Auction opens | 300s after default |
| Auction runs | 900s, Dutch |
| Replenishment of the fund | 5 days |
The 300 second gap between default and auction is deliberate. It is the window in which the first three layers are applied, so that the auction is sized against what is actually left uncovered rather than against the whole position.
Why the order matters more than the size
The useful question for a participant is not "what if a position blows up". It is "how many layers have to burn through before it reaches me". That number is knowable in advance, and it is what lets a clearing member size its exposure without knowing who else is in the book.
Liquidation as a last resort
Forced selling into a thin market turns one participant's failure into everybody's price event. Putting the auction last means the market sees the position only after four layers of capital have already failed to cover it.
The concentration cap exists for the same reason. A position that is large enough to move the price of its own asset cannot be auctioned near its mark, so the protocol refuses to let one accumulate in the first place.
What the other side sees
Nothing. Obligations are independent from the moment of novation, so the member on the other side of the defaulter's trade settles normally against Spire Protocol and is not told that a default occurred. That is the whole purpose of putting a collateralised counterparty in the middle.