Funding Risk
Context
Since Seablocks relies on derivatives positions, such as perpetual contracts, to hedge the delta exposure of its backing assets, the protocol is exposed to Funding Risk.
Funding risk refers to the potential for persistently negative funding rates, where the protocol may need to pay funding fees rather than earn them. While this presents a direct risk to protocol revenue and collateral backing, historical data suggests that negative funding periods tend to be temporary, with funding rates typically reverting to a positive mean.
Negative funding rates are an inherent feature of the derivatives market rather than a flaw. The design of USDi takes this into account to ensure long-term stability.
It is important to acknowledge that historical funding rate data prior to Seablocks' launch does not account for its market impact. The protocol continuously monitors updated funding rate dynamics and will refine its risk framework as more real-time data is collected.
How Seablocks Manages Funding Risk
Seablocks has implemented several key mechanisms to mitigate funding risk:
Reserve Fund: A designated reserve fund is available to cover negative funding rate periods when revenues from liquid staking assets, funding spreads from hedging, and rewards from holding liquid stables result in a temporary net loss. This ensures that the protocol maintains asset stability without passing negative revenue onto users.
Dynamic Allocation Strategy: Seablocks dynamically adjusts the composition of backing assets. During periods of low or negative funding, a greater proportion of the asset backing is shifted into liquid stablecoins earning interest at rates comparable to U.S. Treasury yields. This reduces exposure to negative funding and minimizes the likelihood of reserve fund drawdowns.
Continuous Market Monitoring: The protocol regularly evaluates the funding rate environment across exchanges and adjusts allocations accordingly to optimize yield while reducing risk.
Historical Trends and Positive Bias
Historically, BTC and ETH funding rates have demonstrated a natural positive bias, with average annualized rates between 7.8% - 9% over the past three years, even during the 2022 bear market.
The table below presents a 30-day moving average of funding rates, illustrating the historical trend and highlighting sustained positive biases.
Funding Rate Trends Over Time
Date
BTC Funding Rate (%)
ETH Funding Rate (%)
Jan 2023
8.2
9.0
Feb 2023
7.9
8.7
Mar 2023
8.5
9.2
Apr 2023
7.8
8.5
May 2023
8.3
9.1
Jun 2023
7.6
8.3
Jul 2023
8.0
8.9
Aug 2023
8.4
9.0
Sep 2023
7.7
8.4
Oct 2023
8.1
8.8
Nov 2023
7.9
8.6
Dec 2023
8.6
9.3
The histogram below further visualizes the distribution of annualized funding rates for BTC and ETH, highlighting the natural tendency for funding rates to remain positive over time.
Margin of Safety
Seablocks builds additional resilience against funding risk through multiple layers of margin protection:
Liquid Staking (LST) Collateral: Staking yields from assets like stETH provide a margin of safety against negative funding rates. With an annualized return of approximately 3%, these rewards help counterbalance potential funding losses.
Yield from Liquid Stable Allocations: A portion of the backing assets is allocated to liquid stablecoins, earning yields that serve as an additional buffer.
For protocol revenue to turn negative, the combined sum of LST yield, liquid stable rewards, and funding rate revenue must be negative.
An analysis of funding rates over time shows that only 17.5% of days for ETH and 15.9% of days for BTC had a net negative funding return. When combined with staking income, only 8.84% of days resulted in negative net revenue.
Mean-Reversion and Market Behavior
Funding rates have historically exhibited mean-reverting characteristics—that is, while rates may dip negative, they do not persistently decline and instead trend back toward the mean over time. This is largely due to the natural positive baseline funding observed across major derivative exchanges such as Binance and Bybit, which together account for over 50% of open interest.
The data below shows that negative funding periods tend to revert quickly, with the longest consecutive period of negative funding lasting just 13 days. In contrast, the longest consecutive period of positive funding lasted 176 days, between late 2023 and early 2024.
Conclusion
Seablocks' risk mitigation strategies, including its reserve fund, dynamic allocation, and market-responsive adjustments, ensure that the protocol remains resilient to fluctuations in funding rates. By continuously monitoring funding conditions and optimizing asset allocations, Seablocks minimizes risk exposure while maintaining the stability and sustainability of USDi.
For a more detailed breakdown of funding rate behavior and its impact on USDi, refer to our latest research updates and market analysis.
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