Increment mitigates the risk of insolvency by having an insurance reserve stepping in when needed. If a user has a UA debt (a negative UA balance in the Vault) in which his or her non-UA collateral assets (balances of allowlisted tokens like DAI or WETH) can't cover, then the solvency of the protocol is impacted.

Hopefully this shouldn't happen thanks to liquidation. But if nobody liquidates a position that is below the margin requirements, and this position degrades further without any liquidators stepping in (there's a safety margin of around 3% between the margin requirement and the moment the position is actually at a loss) or other acknowledged risks have prevented liquidations, then said position is no longer over-collateralized and Increment faces a loss because of it.

For instance, in a delayed liquidation scenario, the value of the traders' position minus the liquidation reward would be smaller than the collateral value of the trader. The insurance is designed to step in for such positions which have gone under-collateralized. In other words, the insurance reserve is a backstop layer for the protocol.

The insurance is funded thanks to a small fee collected during various operations:

  1. A fee is collected when traders change their positions (0.1% of the vQuote proceeds).

  2. A fee is collected when LPs withdraw their liquidity (also 0.1% of the vQuote proceeds)

  3. A fee is also collected is when liquidators liquidate a position (~30% of the liquidationReward).

  4. Lastly, the proceeds of selling "dust" is given to the insurance. Note: dust refers to very amounts that can't be swapped in market pools, Increment accumulates these amounts - look at the governance page for more detail on them.

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