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Liquidity stress testing models Meaning

Simulations used by exchanges and protocols to predict how their liquidity will hold up during "extreme" market conditions, such as a 50% price crash or a massive "bank run" of withdrawals. These models help determine if the system has enough "buffer" to remain solvent and functional.

These models test variables like "slippage at scale" and "liquidation cascades." For example, a stress test might ask: "If $100M of Bitcoin is sold in 5 minutes, will the insurance fund cover the resulting bankruptcies?" If the answer is no, the exchange may need to increase its margin requirements or deepen its pools. For decentralized lending protocols, stress testing is critical for setting Loan-to-Value (LTV) ratios.

If an asset is highly volatile and illiquid, the model will suggest a low LTV (e.g., 30%), ensuring that even in a crash, the protocol can sell the collateral fast enough to pay back the lenders.

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