Liquidation Risk
Context
Seablocks primarily uses spot BTC and ETH as backing assets for its short derivatives positions. Additionally, the protocol utilizes staked ETH assets and liquid stablecoins as part of its backing (6% ETH LSTs and 7% liquid stables as of January 2025).
Since the protocol may use different assets than the underlying derivatives positions, and since exchanges operate under a "No Loss" principle, exchanges have the discretion to forcibly close positions if a significant value discrepancy occurs. This process, known as Liquidation, only happens when a position no longer meets margin requirements.
This section aims to highlight how unlikely a liquidation event is, given that Seablocks employs minimal leverage. The protocol’s risk management approach ensures that collateral backing remains sufficient, mitigating liquidation risk under extreme conditions.
Overview
Each exchange’s risk engine requires users to maintain a Maintenance Margin to support existing positions. Many exchanges now employ incremental liquidation mechanisms, which reduce the cost to users by closing positions gradually rather than all at once.
Seablocks' primary focus is ensuring that the value of backing assets remains aligned with the price of the short derivatives positions. This is largely dependent on the spread between the value of staked ETH and ETH itself.
Spread Analysis and Historical Data
Since the Ethereum Shapella upgrade enabled direct unstaking, the stETH/ETH discount has remained below 0.3%. Before Shapella, this spread widened to a maximum of 8%. Given that stETH is now freely redeemable and widely traded, such extreme deviations are unlikely.
Furthermore, exchange risk management mechanisms have historically valued stETH collateral close to ETH, with maximum observed deviations of -3.27% and a median spread of -0.50%.
While each exchange has different risk engines, the following historical data further supports the protocol's ability to maintain margin integrity.
Liquidation Scenarios
The table below demonstrates different stETH discount scenarios and their potential impact on margin requirements:
stETH vs ETH Discount Scenarios
stETH Discount (%)
ETH Value ($)
stETH Value ($)
Margin Requirement Met
0%
2000
2000
Yes
5%
2000
1900
Yes
10%
2000
1800
Yes
15%
2000
1700
Yes
20%
2000
1600
Yes
25%
2000
1500
No
30%
2000
1400
No
35%
2000
1300
No
40%
2000
1200
No
50%
2000
1000
No
65%
2000
700
No
The graph below illustrates the impact of stETH discount levels on liquidation risk. The critical threshold, where liquidation would begin, is marked.
Worked Example: ETHUSD Perpetual
To further illustrate how unlikely liquidation is, let's examine an exchange's Maintenance Margin Requirement (MMR) for a derivatives position.
An exchange assigns an MMR to ensure users maintain sufficient collateral.
If collateral value falls below this threshold, incremental liquidation begins.
Liquidation does not mean an instant loss of all collateral—it involves gradual position reduction.
The following table demonstrates how MMR changes as position size increases:
Position Size ($)
Required Maintenance Margin ($)
10M
5M
50M
25M
100M
50M
Since Seablocks does not employ high leverage, even a position exceeding $100M would require margin coverage of only half the backing assets delegated to exchanges. This demonstrates the extreme improbability of liquidation occurring under normal market conditions.
Internal Risk Management Processes
Seablocks employs multiple proactive measures to prevent liquidation risk:
Additional Collateral Deployment: Seablocks dynamically assigns additional collateral when necessary to enhance margin security.
Cross-Exchange Adjustments: The protocol cycles backing assets across exchanges as needed.
Reserve Fund Utilization: The reserve fund can be rapidly deployed to reinforce hedging positions on exchanges.
Smart Risk Intervention: In extreme events (e.g., smart contract failures), Seablocks takes immediate action, including position rebalancing and asset reallocation.
Additionally, exchanges often discount stETH collateral at a 0.85-1 ratio to ETH to ensure risk is accounted for in the derivatives contract margining. Even with a discounted ratio, liquidation would require an unprecedented spread widening beyond 25%-41%, an event that has never occurred historically.
Common Liquidation Concepts
Understanding liquidation mechanics on centralized exchanges helps clarify risk implications:
Exchange Insurance Funds
All major exchanges operate an Insurance Fund, which absorbs potential user losses.
A portion of trading and liquidation fees are deposited into this fund.
This ensures that profitable traders are paid, even if counterparties fail to meet margin requirements.
Auto Deleveraging (ADL)
Auto Deleveraging (ADL) is a last-resort mechanism some exchanges use if their insurance fund is exhausted.
ADL forces the closure of profitable positions to prevent further losses.
However, ADL is rarely triggered in modern markets due to substantial exchange reserve funds.
Conclusion
Seablocks prioritizes robust risk management to prevent liquidation scenarios. The combination of:
Low leverage
Historical spread resilience
Dynamic collateral adjustments
Active risk management across exchanges
Ensures that the probability of liquidation remains exceptionally low. Even in extreme market conditions, proactive measures safeguard the protocol’s stability and the security of backing assets.
Last updated