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FRM Part II · FRM Exam Part II · Tokenization and Financial Market Inefficiencies

A dealer uses a tokenized platform where a smart contract automatically liquidates collateral when its value falls below 110% of a loan. A loan of USD 10.0 million is secured by tokenized collateral worth USD 11.6 million. The oracle price feed suddenly shows a 6% fall in collateral value because of a faulty data source, though the true market value is unchanged. What is the outcome and the main risk it illustrates?

The faulty feed values collateral at 11.6 x 0.94 = USD 10.904 million, below the USD 11.0 million trigger (110% of the loan), so the contract liquidates wrongly. This illustrates oracle and smart contract risk, since code executes automatically on bad data.

  1. ACollateral appears as USD 10.904 million, which is below the USD 11.0 million trigger, so liquidation is wrongly triggered, illustrating oracle and smart contract riskCorrect
  2. BCollateral appears as USD 10.904 million, which is above the trigger, so no action occurs, illustrating counterparty risk
  3. CCollateral appears as USD 10.9 million, but the trigger is 90%, so no action occurs
  4. DCollateral appears as USD 12.296 million, which triggers liquidation, illustrating interest rate risk

Explanation

A 6% fall gives 11.6 x 0.94 = 10.904 million. The trigger is 1.10 x 10.0 = 11.0 million. Since 10.904 < 11.0, liquidation executes automatically on faulty data, an oracle and smart contract risk. A rise of 6% is wrong in sign and the trigger is 110% not 90%.

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