How Does the Volatility of the Collateral Asset Affect the Required Collateralization Ratio?
The higher the volatility of the collateral asset (e.g. Bitcoin or Ether), the higher the required collateralization ratio must be to maintain the stablecoin's peg.
A volatile asset requires a larger buffer (e.g. 200% collateralization instead of 150%) to absorb sudden, sharp price drops without the stablecoin becoming under-collateralized.
This larger ratio is necessary to give the liquidation mechanism enough time to act before the collateral's value falls below the value of the stablecoins issued against it.
Glossar
Required Collateral
Provision ⎊ Required collateral, within cryptocurrency derivatives, represents pre-funded capital ensuring solvency against potential adverse price movements or counterparty default; it’s a critical component of risk management, particularly in perpetually settled contracts where mark-to-market losses are realized continuously.
Volatility
Measurement ⎊ Volatility, in quantitative finance, is the statistical measurement of the dispersion of returns for a given financial asset, typically quantified by the annualized standard deviation of its price movements.
Required Collateralization
Standard ⎊ The minimum amount of collateral, usually expressed as a percentage of the notional value, that a trader must post to open or maintain a leveraged derivative position, ensuring the counterparty is protected from immediate adverse price swings.
Sharp Price Drops
Trigger ⎊ Sharp price drops, within cryptocurrency and derivatives markets, represent instances of substantial and rapid declines in asset valuation, often exceeding typical volatility parameters.
Required Collateralization Ratio
Margin ⎊ The Required Collateralization Ratio, within cryptocurrency derivatives, represents the percentage of an open position’s value that must be held as collateral to mitigate counterparty risk and potential market exposure.