The Global Financial Crisis (GFC) of 2008 underscored the importance of credit risk in the financial markets. Since 2008, regulatory reform has been introduced to restore stability and confidence in the banking industry. An exciting technological advancement that is set to transform the financial sector is the development of the cryptoasset industry. Although rarely considered in the same context, the cryptoasset industry is not immune to credit and counterparty risk. The frequency of failure due to outright theft highlights the susceptibility to credit risk for bilateral cryptoasset transactions. From 2011 to the first half of 2018, approximately $2.3bn worth of cryptoassets were lost due to scams and cyber hacks, leading to the default of a number of cryptoasset exchanges.
The main use case for cryptoassets is trading. A key component of trading is managing risk, with credit risk being one of the three main categories of risk that cryptoasset traders face. We expect financial institutions and investors will continue to dedicate resources to building a robust infrastructure and developing risk solutions to solve counterparty risk in the cryptoasset industry.
In our first paper ‘Understanding the cryptoasset market’, we outlined the evolving cryptoasset landscape. This second paper provides an insight into the risks inherent to the cryptoasset market and can be broken into three parts. Section one of this paper looks at the significance of credit risk associated with exchanges, custody and prime brokerage services. The second section explores counterparty risk in a traditional financial institutional setting. The final section provides insights on how to extend the traditional credit risk framework to the cryptoasset industry. Overall, we aim to bridge the credit and counterparty risk considerations between incumbent and cryptoasset institutions.
Credit Risk for Cryptoasset
- Centralised Exchanges (CEXs)
- Exchange-Traded Futures
- Decentralised Exchanges (DEXs)
- Custody Services
- Prime Brokerage Services
- PFE and Credit Limits
- Bilateral CVA and Adjustments to Trades Prices
- Basel ll and lll
Extending to Cryptoasset Markets
- Challenges Calculating Regulatory Capital
- Marginal Treatment