Delta Neutral Funding Rate Farming
Last updated
Last updated
Recommended Reading Before Starting: Perpetuals, Funding Rates
One strategy we employ at Elemental is delta-neutral funding rate farming. In a bullish market, perpetual (perp) contracts often trade at a premium to their underlying assets because most traders anticipate rising prices. Under these conditions, long positions pay shorts a funding rate, creating an opportunity for those holding short positions to earn a steady stream of income. This income can become substantial in a strong bull market and often grows even larger when dealing with smaller-cap tokens.
While short positions earn funding payments, they also carry directional risk if held alone. As a fund, we aim to avoid exposure to an asset’s price movement. To achieve this neutrality, we balance a short perp position with an equal spot holding. For example, if we open a 1,000 SOL short in the perp market, we simultaneously hold 1,000 SOL in our spot portfolio. This delta-neutral stance ensures that our overall portfolio value remains stable, regardless of whether SOL’s price rises or falls. Once established, this balanced position allows us to collect funding payments without worrying about price volatility.
Although this strategy can produce reliable income, funding rates themselves can fluctuate significantly. Below, you’ll find an example chart showing how the funding rates of a particular token varied over a month. To provide our depositors with fixed yields, we use our Compound Fund to absorb and mitigate this volatility. In addition, we diversify across multiple token types—ranging from large L1 tokens to smaller altcoins and even memecoins. Each category tends to behave differently, helping smooth out returns at the portfolio level.
We also closely monitor market conditions to avoid remaining in positions during periods of negative funding rates. Through active management, we rotate position sizes and redistribute capital to maintain profitability. By remaining agile, we preserve the advantages of this strategy and continually fine-tune our exposure to funding opportunities.
Some funds employ this delta-neutral strategy but use dynamic collateral, such as JLP. While this is theoretically possible, it is extremely complex and introduces additional layers of risk. Maintaining a perfectly delta-neutral position with dynamic collateral is not currently feasible with existing infrastructure. Continuous rebalancing would be required, incurring slippage on every trade, ultimately making the costs prohibitive.
To work around these constraints, funds that use dynamic collateral often accept a degree of partial directional exposure. Furthermore, any significant market moves can result in higher slippage, leading to larger-than-expected losses for depositors. Because prices and positions change constantly, such strategies require around-the-clock monitoring and automated scripts for rebalancing.
We applaud innovation but urge caution when considering funds that have not properly audited their automated scripts. There have been public cases in which poorly designed scripts led to substantial depositor losses. Additionally, current Web3 technology has its limitations, and events such as a Solana chain halt remain a possibility. If the chain halts, a dynamic-collateral, delta-neutral strategy could end up with a large unhedged position, leading to severe losses.
At present, Elemental chooses to avoid these vulnerabilities altogether. We may explore dynamic collateral in the future if we can implement the rigorous risk management controls necessary to meet our standards.
Risk management is our highest priority at Elemental. By employing a delta-neutral approach, diversifying assets, actively monitoring funding conditions, we aim to provide a stable environment for our depositors.
