Free CAIA Level I Digital Assets Practice Questions

C is correct. A smart contract is a program stored on a blockchain that automatically executes predefined actions when specified conditions are satisfied. It removes the need for intermediaries by encoding agreement terms directly into code.
Choice B is incorrect because a smart contract is not a traditional legal document stored in a court database; it is executable code on a blockchain.
Choice A is incorrect because a digitally signed traditional contract is simply an electronic version of a conventional agreement, not a self-executing blockchain program.
Choice D is incorrect because a verbal agreement validated by an exchange is neither self-executing nor stored on a blockchain, which are defining characteristics of a smart contract.

D is correct. Because smart contracts are immutable once deployed and execute automatically, any bugs or security vulnerabilities in the code can be exploited by attackers. Since blockchain transactions are generally irreversible, funds lost through such exploits are extremely difficult or impossible to recover.
Choice A is incorrect because smart contracts on public blockchains execute without requiring regulatory approval; they are permissionless by design.
Choice B is incorrect because smart contracts operate continuously on the blockchain network, which runs 24/7 without regard to business hours or jurisdictions.
Choice C is incorrect because smart contract execution speed depends on network throughput and block times, not the physical location of the parties involved.

B is correct. Maximum drawdown captures the worst peak-to-trough decline and the duration of the drawdown, providing information about path-dependent risk that variance and standard deviation do not convey. A 70%+ drawdown over many months poses liquidity, margin, and governance challenges for institutional investors that a single annualized volatility number obscures. Furthermore, historical episodes show that during severe crypto drawdowns, correlations with risk assets tend to increase, compounding portfolio losses precisely when diversification is most needed.
Choice A is incorrect because standard deviation measures the dispersion of returns symmetrically and does not capture the magnitude, duration, or path-dependent nature of extreme drawdowns. Fat-tailed distributions mean that variance systematically underestimates the probability and severity of extreme losses.
Choice C is incorrect because eventual price recovery does not negate the risk of severe interim losses. Institutional investors face margin calls, redemption pressures, and fiduciary obligations during drawdowns that may force liquidation at adverse prices before any recovery occurs.
Choice D is incorrect because the assumption that institutions can always rebalance at the trough ignores real-world constraints such as liquidity freezes, exchange failures, board restrictions, and the behavioral difficulty of committing additional capital during extreme stress.