Value-at-Risk Limitations

Value-at-Risk Limitations arise because the metric is based on historical data and assumes normal market distributions, failing to account for fat-tail events. It provides a single number that can give a false sense of security, ignoring the severity of losses that occur beyond the confidence threshold.

Furthermore, VaR does not capture the impact of liquidity crises or sudden changes in market correlation. It is a backward-looking tool that may not be relevant in rapidly evolving markets like cryptocurrency.

Because it ignores the magnitude of tail risk, it can lead to dangerous underestimation of potential disaster. Relying solely on VaR can be a critical error for traders and protocols.

It must be complemented with other metrics like Expected Shortfall and rigorous stress testing. Acknowledging its flaws is essential for responsible risk management.

It is a useful tool, but only when used with a clear understanding of its boundaries.