How Do Market Crashes Affect the Correlation between a Volatile Collateral Asset and the Underlying Derivative?
During market crashes, the correlation between a volatile collateral asset (e.g. BTC) and the underlying derivative (e.g.
BTC perpetual future) often approaches 1 (perfect correlation). This means that as the derivative's price falls, the value of the collateral backing the position also falls simultaneously.
This "double-whammy" effect drastically accelerates the decline in the trader's equity, rapidly triggering margin calls and cascading liquidations, thereby increasing systemic risk for the exchange.
Glossar
Volatile Collateral
Exposure ⎊ Volatile collateral, within cryptocurrency derivatives, represents assets pledged to secure positions where underlying value is subject to rapid price fluctuations.
Volatile Collateral Asset
Definition ⎊ A Volatile Collateral Asset is a digital asset, typically a major cryptocurrency, whose market price exhibits high standard deviation and significant price swings, yet is accepted as security for margin or options contracts in the crypto derivatives market.
Correlation
Interdependence ⎊ The concept of correlation, within cryptocurrency derivatives and options trading, fundamentally describes the statistical relationship between two or more assets, indices, or variables.
Market Crashes
Event ⎊ Market crashes are sudden, severe, and rapid declines in asset prices across major sectors, often triggered by unexpected negative catalysts or the failure of a major financial intermediary.