The International Swaps and Derivatives Association has created a new working group to help establish market standards for crypto derivatives, a potentially significant step in fostering growth in the fledgling asset class.
“Financial institutions [are] showing more interest in crypto and derivatives linked to these assets. Further growth is all but certain, but the challenge will be to guarantee the nascent market for digital asset derivatives is built on firm foundations,” ISDA chief executive Scott O’Malia wrote in an article on the trade body’s website.
“This should be based on standards that respect the unique aspects of this asset class and can be applied in a fully digital format – an issue that ISDA is uniquely placed to tackle,” he added.
Trading in crypto assets such as bitcoin has surged in recent years, prompting banks and other finance firms to explore getting involved in this part of the market.
Average daily trading volumes across all digital asset investment products reached US$566m in September, according to crypto market data provider CryptoCompare. Assets under management in such products stood at US$51bn as of September 24, CryptoCompare said.
There have been some well-publicised moves to develop crypto derivative markets, most notably CME Group launching bitcoin futures and options as well as ether futures. Citigroup is one major bank that is currently looking into trading bitcoin futures on CME.
ISDA has been responsible for developing standard legal documentation governing the vast majority of the US$582trn over-the-counter derivatives market, including for interest-rate and credit-default swaps, as well as for foreign exchange, equity and commodity derivatives. Those standards have been instrumental in building liquidity in these markets over the past few decades.
O’Malia noted that firms trading crypto derivatives tend to use an amended version of existing ISDA definitions and templates (such as for equity or FX derivatives) or entirely bespoke documentation.
"That’s not ideal: it results in a lack of standardisation that may ultimately hamper transparency and liquidity and lead to higher levels of risk,” O’Malia wrote.
There are a number of peculiarities to crypto derivatives that existing documentation might not cover, O'Malia wrote, such as when a crypto asset’s blockchain is upgraded or modified to fix glitches. The ISDA working group will attempt to develop specific legal standards for crypto derivatives that will address this and other issues such as the scope of products, trade settlement and valuations.
“Addressing these topics is the starting point for developing the market-standard documentation that is critical for legal certainty, as well as ensuring robust processes are in place to deal with market disruptions or defaults,” O’Malia wrote, adding ISDA would engage with crypto market participants as part of the process. “While crypto derivatives may be different to other asset classes, the process of bringing market participants together to reach consensus on industry standards is the same."