A contract loss is when a trader is liquidated under their Bankruptcy Price, meaning he or she has lost more than their Initial Margin. This can happen due to the difference between the Mark Price, which triggers Liquidation, and the Last Traded Price, at which the position will be closed. The Insurance Fund is used to cover the contract loss.
As long as the Insurance Fund has sufficient funds, it is used in lieu of auto-delveraging where a contract loss occurs. The Insurance Fund can be checked here.
Funds go into the Insurance Fund when a position is closed at a price better than the Bankruptcy Price, and are taken from it when a position is closed at a price worse than its Bankruptcy Price.
For example, trader A and trader B have different Long positions with Bankruptcy Price A at $8,730 and Bankruptcy Price B at $8,680. Both, however, have a Liquidation Price at $8,750. When they get liquidated, the Last Traded Price is at 8,700. Trader A is liquidated under his Bankruptcy Price and would thus take away from the Insurance Fund, while trader B is liquidated over his Bankruptcy Price and would thus add to the Insurance Fund.
Please note that the actual amount deposited/taken to/from the Insurance Fund would not be the difference between the Last Traded Price and the Bankruptcy Price but is equal to the Initial Margin remaining or the contract loss. Also please note that a price better or worse than the Bankruptcy Price is dependent on the position taken, long or short, as for a short position a price better than the Bankruptcy Price would actually be lower than the said price.
Adhering to Bybit’s principles of fair trading, the Insurance Fund is used to protect traders from the losses incurred by other high-risk traders and mitigate risks.