Settlements

Settlements in the Fiet Protocol ensure market makers deliver liquidity to AMM pools to meet trading demand, maintaining market stability. A Request for Settlement (RfS) triggers when additional liquidity is needed, guided by the Value-to-Signal (VTS) model. Given settlement risk concerns, Fiet employs mechanisms — collateralisation, guarantors, and proof of settlement — to mitigate risks and protect user funds, ensuring traders’ assets remain secure in a non-custodial environment.

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How Settlements Work

An RfS is triggered when the VTS ratio for a currency falls below its target, indicating a liquidity shortfall. Market makers must settle the required amount, proportional to their VRL commitment, within a fixed grace period (set at market deployment, e.g., based on bank transfer times). If they fail, settlement guarantors — other market makers or bots — can settle on their behalf, seizing the failing market maker’s collateral or liquidity position as profit. This incentivises timely delivery while ensuring market continuity.

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Managing Settlement Risk

Fiet mitigates settlement risk through multiple safeguards:

• Collateralisation: Market makers deposit a base VTS collateral (e.g., 2% of their commitment) on-chain, securing their obligations and incentivising guarantors to intervene if needed.
• Seizure Mechanism: After the grace period, a failing market maker’s position is seizable on a linear scale (e.g., fully seizable after an hour), ensuring guarantors act swiftly to restore liquidity.
• Proof of Settlement: Market makers can submit zkTLS-verified proof of pending settlements (e.g., a bank transfer) to extend the grace period, reducing seizure risk during delays.
• Looping: Guarantors with smaller reserves can partially settle and seize proportional positions, iterating until the RfS is fulfilled, broadening participation.

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Protecting User Funds

Traders’ funds are protected by Fiet’s non-custodial design and protocol-bound LCCs:

• Non-Custodial: Traders retain control of their assets, swapping LCCs in the DEX without Fiet holding funds.
• LCC Restrictions: LCCs are non-transferable, locked to Fiet’s DEX, preventing misuse or external risks.
• Guarantor Backstop: If a market maker fails, guarantors deliver liquidity, ensuring traders receive their swapped assets.
• Collateral Buffer: The base VTS collateral absorbs potential shortfalls, protecting traders from losses.

For example, in a USDC/ETH market, if a trader swaps $100,000 USDC for ETH and the market maker fails to settle, guarantors cover the ETH, seizing the market maker’s $2,000+ collateral, ensuring the trader’s ETH is delivered.

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Sequence Diagram

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Guarantor Incentive Structure

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Context

In an AMM pool with virtual and realised liquidity, MMs deposit a base collateral equal to 2% of their committed liquidity per currency.

Consider a USDC/XYZ pool, with $C_{\text{total}}$ = $1,000,000, at a 1:1 exchange rate in a 50/50 pool — using a constant sum invariant price algorithm for the sake of simplicity.

The pool initially holds:

• Realised Liquidity: $10,000 USDC and $10,000 XYZ.
• Virtual Liquidity: $980,000 USD ($1,000,000 total from MMs’ commitments minus realised liquidity)

A trader swaps $100,000 USDC for $100,000 XYZ.

The swap requires $100,000 XYZ, but the pool initially holds only $10,000 XYZ in realised liquidity, leaving a shortfall of $90,000 XYZ that MMs must settle proportionally to their commitments.

If MM A holds 50% of the pool ($C_{\text{MM}_A}$ = $500,000), their settlement obligation is $45,000 XYZ ($a_{\text{MM}_A}$ = 0.5 $\cdot$ $90,000). If MM A fails to settle, another MM (e.g., MM B) can settle the $45,000 XYZ on MM A’s behalf and seize MM A’s liquidity position.

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Calculations

• Trader’s Action: Deposits $100,000 USDC, withdraws $100,000 XYZ.
• Pool’s Realised Liquidity Before Settlement:
  • USDC: $10,000 + $100,000 = $110,000
  • XYZ: $10,000 - $10,000 = $0 (pool provides its $10,000 XYZ to trader, shortfall remains $90,000 XYZ)
• MM Settlement: MMs collectively settle $90,000 XYZ
• Realised Liquidity After Settlement
  • to Pool: $110,000 USDC, $90,000 XYZ
  • to Trader: $110,000 USDC, $0 XYZ

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MM A’s Liquidity Position

MM A’s 50% share of the pool’s realised liquidity post-swap is $55,000 USDC (0.5 $\cdot$ $110,000)

Since the pool has $0 XYZ post-settlement, MM A’s position is valued at $55,000 USDC.

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Guarantor’s Profit

If MM B settles MM A’s $45,000 XYZ obligation:

• MM B seizes MM A’s position: $55,000 USDC.
• Profit = $55,000 USDC - $45,000 XYZ = $10,000 (assuming 1:1 value).

This $10,000 profit equals half of MM A’s base collateral ($5,000 USDC + $5,000 XYZ = $10,000), incentivising MM B’s intervention.

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Incentive Mechanism

The base collateral acts as an incentive for guarantors (e.g., MM B) to settle on behalf of a failing MM (e.g., MM A), as the seized liquidity position’s value ($55,000 USDC) exceeds the settlement cost ($45,000 XYZ), yielding a profit equal to the failing MM’s proportional collateral. This ensures market liquidity and operational stability.

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Learn More

Explore related concepts and details:

• Value-to-Signal: See how VTS triggers RfS.
• Liquidity Commitment Certificates: Understand LCCs’ role in settlements.
• Markets: Learn about AMM pools requiring settlements.
• Technical Specification: Review settlement mechanics.
• Join the Community: Discuss settlement risks on Discord.