When Auto-Deleveraging (ADL) is triggered on a decentralized perpetual protocol, losses are not covered solely by either the insurance pool or liquidity providers (LPs). Instead, the insurance pool acts as the first backstop, any remaining uncovered losses are then passed to profitable traders/LPs, and liquidity providers ultimately cover all leftover losses.
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This forms a tiered loss mitigation chain, where the insurance fund is the first line of defense, and ADL is the final mandatory measure.
Tier 1: Insurance Fund — The First Line of Defense
Almost all mainstream decentralized perpetual protocols set up an insurance fund to absorb losses from bankrupt positions.
dYdX has very clear rules: when an account has a negative balance, the insurance fund is the first backstop. After the liquidation engine takes over the position, all resulting profits and losses are absorbed by the insurance fund, and the auto-deleveraging (ADL) process only starts once the insurance fund is fully depleted.
Hyperliquid's HLP (Hyperliquidity Provider) serves a similar role. One of its core functions is to act as the "backstop liquidation party" — when market depth is insufficient for regular liquidations to complete, HLP steps in to take over bankrupt positions and maintain the protocol's solvency.
The prerequisite for losses to be covered by the insurance pool is that its remaining balance is sufficient.
Tier 2: ADL — Mandatory Measure After Insurance Pool Depletion
If the insurance fund is not enough to cover the losses from undercollateralized bankrupt positions, the system moves to its final line of defense: ADL (Auto-Deleveraging).
The logic of ADL is: The system forcibly closes partial positions of profitable traders, using their unrealized profits to cover the deficits of the bankrupt losing traders. The core criteria for selecting which traders get their positions reduced is a "profit × leverage" priority score — traders with higher profits and higher leverage get selected first.
dYdX's official documentation explains this process with an example: when a losing account's deficit cannot be covered by the insurance fund, the system finds a profitable account holding the opposite position as a counterparty, transfers the bankrupt account's negative balance to this profitable account, and reduces the profitable account's position size, so the profitable account takes on a portion of the loss.
Tier 3: LPs (Liquidity Providers) — The Final Bearer of ADL Losses
After ADL is triggered on a decentralized perpetual protocol, the loss allocation path follows this order:
Insurance fund is used first: Losses are drawn directly from the insurance pool balance.
Insurance fund depleted → ADL activates: Profitable traders are force-deleveraged, and the portion of profits they would have otherwise earned is used to fill the deficit.
What if ADL still can not cover all losses? On many protocols, liquidity providers (LPs) act as the final risk absorption layer.
Lighter's LLP Strategies mechanism is a typical example. It splits the liquidity pool into separate strategy modules, each with an independent capital cap. When ADL is triggered for a specific strategy, losses are strictly limited to the pre-allocated funds of that strategy, and will not spill over to other LPs on the protocol.
In February 2026, Lighter experienced a $50M short squeeze event on the ARC perpetual contract, where a large number of short positions pushed back against a single large long whale. The ADL process for that specific strategy module only caused LPs to lose 75,000 USDC in total — because losses were locked within that sub-strategy's capital cap, and never spread to the entire protocol.
This directly answers the core question: When ADL is triggered on a decentralized perpetual protocol, losses are not covered unilaterally by the insurance pool or LPs. The insurance pool covers losses first, any uncovered losses are then passed to LPs, and the maximum loss for LPs depends on the protocol's risk isolation design.
A Commonly Overlooked Detail: ADL Itself Does Not Generate Extra Revenue
Hyperliquid co-founder Jeff Yan has clarified that the ADL mechanism does not transfer profits or losses to HLP, and ADL handles regular users and HLP in a fully symmetric way, it will not transfer gains from one party to the other. This means:
ADL is not the protocol "stealing user funds", it is just a reallocation within the zero-sum trading system.
Traders who get deleveraged via ADL only lose the extra profits they would have otherwise earned, they do not lose their initial principal.
LP losses are essentially part of the protocol's pre-defined risk design, they are not "eaten" by the ADL mechanism itself.
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Verification Method to Confirm Allocation Rules
If you trade on a decentralized perpetual protocol and want to confirm who will bear losses after ADL triggers, you can check with two simple steps:
Check the real-time balance of the protocol's insurance fund: Protocols like dYdX make their insurance fund address public, so you can check the current balance directly on-chain. The closer the balance is to zero, the higher the chance ADL will be triggered.
Check the protocol's risk isolation mechanism: If the protocol uses a "separate strategy allocation" model like Lighter, LPs have a clear maximum loss cap. If it uses a unified shared pool model (such as GMX and Avantis's general USDC vault), losses will be spread across all LPs, leading to higher overall risk.
