FRM Part II · FRM Exam Part II · Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets
A risk manager reviews a crypto exchange group that holds client Bitcoin in custody, runs its own proprietary trading desk, and lends client assets to affiliates to fund leveraged positions. A sudden 40% price fall triggers client withdrawals exceeding the liquid assets available. Which risk combination best explains the group's vulnerability?
The vulnerability stems from commingling and rehypothecation of client assets, combined with leverage and a liquidity mismatch between on-demand withdrawals and illiquid or devalued assets. A sharp price fall amplifies losses and triggers a run. The other options describe risks that are not present in the described structure.
- AInterest rate risk on its bond portfolio combined with reserve requirement breaches
- BSettlement risk from T+2 securities clearing combined with central counterparty default
- CCommingling and rehypothecation of client assets combined with leverage and a liquidity mismatch, producing a run-like dynamicCorrect
- DForeign exchange translation risk combined with sovereign default on reserve holdings
Explanation
Using client assets for affiliate lending and proprietary leverage creates a mismatch between liabilities that can be withdrawn on demand and assets that are illiquid or have fallen in value. The price fall amplifies leverage losses and triggers a run. The other options describe risks not present in the scenario, such as bond portfolios, CCP clearing or sovereign reserves.
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