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

A risk manager notes that during a sharp crypto price fall, leveraged positions on a platform are automatically liquidated, pushing prices down further and triggering more liquidations. Which feature of crypto markets does this best illustrate?

This shows procyclical leverage with fire-sale dynamics. Falling prices trigger automatic liquidations, the forced selling pushes prices lower, and that triggers more liquidations, amplifying the decline in a self-reinforcing loop.

  1. AProcyclical leverage and fire-sale dynamics amplifying price declinesCorrect
  2. BCounter-cyclical collateral buffers dampening volatility
  3. CCentral bank lender-of-last-resort support stabilising prices
  4. DNetting benefits reducing aggregate exposure

Explanation

Automated margin liquidations force selling when prices fall, which lowers prices and triggers more liquidations. This feedback loop is procyclical leverage. Crypto markets lack a lender of last resort and stabilising buffers, so the other options do not apply.

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