CAPM Limitations

The Capital Asset Pricing Model relies on assumptions like efficient markets, rational investors, and normal distribution of returns, which often fail in the context of cryptocurrencies and complex derivatives. In crypto markets, asset returns frequently exhibit fat tails and extreme volatility that the standard beta coefficient cannot capture.

Furthermore, the model assumes borrowing and lending at a risk-free rate, which is not applicable to decentralized finance protocols where collateral requirements and interest rates are highly variable. It also ignores liquidity risk, which is a primary driver of price discovery in digital asset markets.

Consequently, using CAPM to price crypto assets or derivatives can lead to significant mispricing and underestimation of systemic risk. The model essentially assumes a static environment, whereas crypto markets are dynamic and highly reflexive.

Investors often face constraints that prevent them from holding perfectly diversified portfolios, violating the model's core premises. Therefore, relying solely on CAPM for valuation in these domains is insufficient and potentially dangerous.