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FRM Part II · FRM Exam Part II · Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets

A pension fund's risk committee is told that a crypto lender's collateral consists mainly of its own exchange token. During a market sell-off, the token falls sharply, margin calls rise and the lender halts withdrawals. Which risk dynamic is most clearly illustrated?

This shows procyclical leverage combined with wrong-way collateral risk. Collateral in the platform's own token loses value just when the platform is stressed, so margin calls and forced sales push prices down further, creating a self-reinforcing spiral that can end in halted withdrawals.

  1. AProcyclical leverage and wrong-way collateral risk creating a self-reinforcing spiralCorrect
  2. BBasis risk from imperfect hedging with futures
  3. CModel risk from using normal distribution VaR
  4. DSettlement risk from different time zones

Explanation

Collateral issued by the borrower or its affiliate is correlated with the borrower's credit quality, which is wrong-way risk. Falling prices trigger margin calls and forced selling, pushing prices lower, which is procyclical leverage. The other options are not the central mechanism described.

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