Funding Risk

Funding risk is the potential that a financial entity or protocol cannot meet its payment obligations when they fall due without incurring unacceptable losses. In the context of cryptocurrency derivatives, this often manifests as the inability to maintain necessary margin requirements to support open positions.

When liquidity dries up or volatility spikes, the cost of borrowing assets to maintain collateral increases dramatically. If a trader or protocol cannot secure this liquidity, they may face forced liquidation, leading to a cascade of sell orders.

This risk is deeply intertwined with systems risk and contagion, as one participant's failure to fund their position can trigger further liquidations across the ecosystem. It highlights the vulnerability of highly leveraged strategies that rely on continuous access to capital markets.

Effectively managing this risk requires maintaining sufficient liquid reserves and understanding the underlying market microstructure.