19 January 2022

ISDA: Developing Contractual Standards for Crypto Derivatives

As in any wholesale market, over-the-counter (OTC) derivatives have a vital role to play in broadening market access, facilitating risk management and price discovery, deepening liquidity, and providing greater certainty and flexibility to market participants.

The extraordinary growth of crypto assets in recent years has become one of the defining features of modern finance. With a market value of around $3 trillion, this is now a well-established asset class that is increasingly attracting the attention of institutional investors and banks. As in any wholesale market, over-the-counter (OTC) derivatives have a vital role to play in broadening market access, facilitating risk management and price discovery, deepening liquidity, and providing greater certainty and flexibility to market participants.

ISDA is now working to develop legal standards to support the crypto derivatives market, with input from a range of stakeholders, including those active in the crypto space. The aim is to align the crypto derivatives market with the existing spot market by creating strong legal foundations. Last year, we established the ISDA Digital Assets Legal Group and, in December, we published a paper that explores the key issues that need to be addressed in any contractual standards for OTC derivatives, including disruption events, valuation and documentation.

Until now, institutions have largely traded digital asset derivatives using amended versions of existing ISDA definitions and templates, or using their own bespoke documentation. That not only leads to a lack of standardization; it may mean that certain unique events that may occur in the crypto assets market are not directly covered by the documentation used for derivatives linked to those assets. We think there is a need for standard derivatives documentation that is tailored to reflect the unique features of this asset class.

There are several distinctive features and events that need to be considered in any standard derivatives documentation. These include forks, where a blockchain is upgraded or modified, which can change the nature of the blockchain or lead to the creation of two distinct crypto assets. These types of disruption events can impact the valuation, settlement, collateral and legal viability of a transaction, so it’s important the documentation clearly identifies and defines the relevant events, as well as the potential consequences.

We’re now looking closely at how these disruption events and other specificities of crypto assets should be addressed in contractual standards, and how those standards should be integrated within the existing ISDA documentation architecture, particularly the ISDA Master Agreement.

Working on contractual standards and documentation templates for digital asset derivatives is a priority for ISDA this year. We’ll start by developing standard terms for products that are already traded in the market today, such as cash-settled forwards and options referencing Bitcoin and Ether. We will then consider how we might add value for other types of products, including those traded on decentralized and hybrid trading venues.

To enable broad-based adoption of these standards, it is vital that they are produced in a form that reflects the unique characteristics of this market. ISDA will therefore create templates and definitions that support the development of on-chain smart contracts for crypto derivatives. These standards will be designed to integrate seamlessly within the infrastructure being developed to support this market, and in a manner that promotes interoperability between different distributed ledgers and platforms.

Robust contractual standards for digital asset derivatives will promote greater efficiency, deeper liquidity and reduced risk in this fast-growing market. As this work progresses, we’ll continue to engage closely with all market participants, including our crypto asset members, and we encourage other crypto market participants interested in joining the conversation to get in touch.

Read ISDA’s paper: Contractual Standards for Digital Asset Derivatives

ISDA

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