Funding Risk
Context
Given Ethena uses derivatives positions, such as perpetual contracts, to hedge the delta of the digital asset collateral, the protocol is exposed to "Funding Risk".
"Funding Risk" relates to the potential of persistently negative funding rates. Ethena is able to earn a yield from funding, but could also be required to pay funding.
While this is a direct risk to the protocol yield, the data presented below demonstrates that negative yields tend not to persist and revert to a positive mean.
Negative funding rates are a feature, rather than a bug of the system. USDe has been built with this in mind.
We acknowledge that historical data before Ethena's launch does not reflect Ethena's impact on the market. We are monitoring updated funding rate dynamics and will provide updates to this section as we collect the new data.
How Ethena manages Funding Risk
An Ethena reserve fund exists and will step in on occasions when the combined yield between LST assets, such as stETH, and the funding rate for a short perpetual position, is negative. This seeks to protect the spot backing underpinning USDe. Ethena does not pass on any "negative yield" to users who stake their USDe for sUSDe.
Positive Bias
ETH funding rates have exhibited natural positive bias and contango, with an average annualized rate of between 6% - 8% over the last 3 years on an open interest or volume-weighted basis, including the 2022 bear market.
Below represents the 30d moving average of funding rates, indicating that positive bias is evident, particularly in 2021 and 2023.
Charting the distribution of funding rates per contract, one can further see the positive bias per exchange, with the coloured box per contract indicating the middle 50% of datapoints. That middle 50% of funding data is predominantly positive values on most exchanges.
Margin of Safety
Using LST collateral, such as stETH, as collateral for USDe, provides an additional margin of safety for negative funding in the form of the 3-5% annualized yield earned on stETH.
That is to say, protocol yield will only be negative when the combined LST yield and funding rate sum to be negative.
Looking at annualized funding rate values, one observes 19.1% and 16.1% of days had a sum negative yield for ETH and BTC perpetual futures respectively, with an average yield over the entire period of 8.79% for ETH versus 7.63% for BTC.
Combining annualized stETH yields and ETH funding rate values, one observes only 10.34% of days had a sum negative yield. This excess yield could be seen as an upper bound to protocol yield. That compares positively when compared to the ~20.5% of days yielding a negative funding rate when not also incorporating the stETH yield.
There has only been one quarter in the last 3 years where the average sum yield was negative and this data was polluted by the ETH PoW arbitrage period which was a one-off event that dragged funding deeply negative.
Mean-reversion
Funding rates have displayed mean-reverting characteristics, which is to say they may dip negative but those rates do not persist and don't drift lower over time. Positive baseline funding on some of the biggest derivative exchanges, with over 50% of open interest (Binance & Bybit), help keep funding rates naturally positive.
Reversion to a positive mean can be seen in the longest consecutive days of either positive or negative funding rates. Negative funding rates revert quicker thanks to the dynamics described above, with the longest streak of consecutive days with negative funding lasting just 13 days.
The longest streak of positive funding days has been 108 days, set in 2023 and charted below
For a more detailed explanation on the distribution of funding rates as it relates to USDe, please read this Twitter thread from the Ethena Labs founder on the topic.
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