How Does the Correlation between the Stablecoin and Its Collateral Token Affect Stability?
In a dual-token algorithmic system, a positive correlation between the stablecoin and the volatile governance token is a major risk. If the market crashes, both tokens fall in price.
The drop in the governance token's price weakens the stabilization mechanism, and the drop in the stablecoin's price triggers the mechanism, leading to a procyclical failure where the tokens drag each other down.
Glossar
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.
Procyclical Failure
Cascade ⎊ Procyclical failure within cryptocurrency, options, and derivatives manifests as a systemic amplification of market stresses, originating from initial margin calls or liquidations.
Positive Correlation
Relationship ⎊ Positive Correlation describes a statistical dependency where two or more variables, such as the price of a spot asset and the price of its related derivative, tend to move in the same direction over time, although the relationship is rarely perfect.