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

During a sharp price fall, a crypto lending platform sees many leveraged positions auto-liquidated, which pushes prices down further and triggers more liquidations. This dynamic is best described as:

This is a procyclical feedback loop. Falling prices trigger automatic liquidations of leveraged positions, the forced selling pushes prices lower, and that prompts further liquidations. Leverage and automated margin mechanisms amplify the downturn, making crypto markets vulnerable to fire-sale spirals.

  1. AA procyclical feedback loop amplified by leverage and forced sellingCorrect
  2. BA diversification benefit from independent positions
  3. CBasis risk arising from hedging with futures
  4. DSettlement finality provided by distributed ledger technology

Explanation

Automated liquidations of leveraged positions force selling into a falling market, depressing prices and triggering further margin calls. This is a procyclical, self-reinforcing loop. It is not diversification, basis risk or settlement finality.

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