Isda proposes market rules to cover crypto disruptions

To increase the appeal of digital assets to institutional investors, disruptions unique to cryptocurrency markets will be included in contracts for the global derivatives industry for the first time.

Isda, the derivatives trade association, said on Tuesday it was developing common legal standards and templates for derivatives linked to the $3 trillion crypto market to cover “potential disruptive events.”

Among the potential problems highlighted by the London-based panel in a white paper were cyberattacks; Forks, when a blockchain effectively splits into two branches; and airdrops, when the market is flooded with tokens, usually for free.

Isda's master agreements are widely used as a legal template for most of the world's derivatives trades in bonds, stocks, currencies and other common assets. Market participants generally follow its guidelines for adjusting contract terms when an unexpected event disrupts the performance of a derivative.

Scott O’Malia, CEO of Isda, said the standards and definitions for digital derivatives would align with the underlying or spot market. “We need to respect that crypto assets are a unique class of products and develop the definitions and legal terms accordingly,” he said.

The move comes as the crypto derivatives market increases in value and activity, with products like Bitcoin and Ether futures on the Chicago Mercantile Exchange attracting more users. Last month, average open interest for Bitcoin and Ether futures reached 4.3 billion. The derivatives market now accounts for 55 percent of the total crypto market, he added.

As it grows, some of the largest crypto market participants are increasing their lobbying of regulators to try to shape the rules.

Last week, Coinbase, the crypto exchange, and FTX.US, the derivatives trading market, both joined Isda, a long-established trade association whose members consist primarily of the world's major investment banks and asset managers.

“Institutional market participants will be more willing and able to invest and trade in crypto assets if the mechanisms for doing so reflect current processes and standards,” said Kevin McPartland, head of market structure research at Coalition Greenwich.

When a cryptocurrency splits, market infrastructure providers such as trading venues, custodians and index providers may need to choose which branch of the asset to support. Airdrops could impact a derivatives transaction by increasing the market value of the digital asset native to the beneficiary network, it said.

Isda has begun adjusting its standards as traders and IT programmers explore the possibilities for trading derivatives contracts controlled by computer code. Earlier this year, it digitized its extensive booklet of legal documents, the biggest overhaul of its rulebook since 2006.

FTX has also forayed into the regulated derivatives markets by purchasing LedgerX, a cryptocurrency futures exchange and clearinghouse, for an undisclosed amount in October.