What Is the Relationship between Liquidation and Systemic Risk?
Liquidation mechanisms are designed to mitigate systemic risk by ensuring that individual under-collateralized positions do not threaten the entire stablecoin system's solvency. However, in extreme market crashes, mass liquidations can flood the market with collateral assets, driving their price down further and triggering more liquidations, potentially leading to a 'liquidation cascade' that increases systemic risk.
Glossar
Systemic Risk
Contagion ⎊ Systemic risk within cryptocurrency, options trading, and financial derivatives manifests primarily through interconnectedness, where the failure of one entity can propagate rapidly across the system.
Under-Collateralized Positions
Exposure ⎊ Under-collateralized positions in cryptocurrency derivatives represent a systemic risk vector where the notional value of open contracts exceeds the value of the collateral securing them, creating potential for cascading liquidations.
Circuit Breakers
Intervention ⎊ Circuit breakers, within cryptocurrency and derivatives markets, represent pre-defined mechanisms to temporarily halt trading during periods of substantial and rapid price declines or increases.