Rebalancing is the process by which the protocol seeks to respond to changes in liquidity risk by buying or selling Asset for Capital.

Rebalancing is essentially a dynamic hedging engine. When triggered, the algorithm looks at the current liquidity ratios and compares these with a set of corresponding reference (target) ratios in order to calculate how to minimise differences between liquidity ratio and reference, thereby ensuring that the available liquidity is evenly distributed against the market’s liabilities. The objective of rebalancing is to minimise the risk of insolvency.

The algorithm is composed of several stages:

  1. Calculate liquidity ratios and reference ratios

  2. Calculate the Asset and Capital Ledgers

  3. Determine swap strategy

  4. Execute the swap

  5. Execute same-side rebalancing with the new values for total Assets and total Capital

Currently, steps 1 to 3 are collectively referred to as “Cross-Side Rebalancing” (CSR). In conjunction with a swap, CSR is the main process by which a protocol market can protect the total value of the pooled assets and capital in the system. It does this by firstly assessing the protocol’s internal measures of liquidity (i.e. the liquidity ratios), and comparing them against a set of dynamic reference ratios. This information is passed to the swap logic which will return a signal to either buy Assets, sell Assets, or do nothing.

Same-Side Rebalancing (SSR) involves moving values between Pool and Reserve on both the Asset and Capital side once the total value of each respective side is known. SSR operates whether or not a swap was executed in response to changes in liquidity risk.

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