Crypto should be considered a separate sector for its use cases in derivatives margin trading. This is what the US Federal Reserve economists have proposed very recently. The team released a working paper stating that cryptocurrencies are volatile and can significantly impact derivatives pricing and overall financial stability.
Federal Reserve researchers split crypto into two groups
When compared to traditional assets like commodities, equities, foreign exchanges, or interest rates, crypto is highly volatile. As such, crypto does not fit well into the risk buckets used by financial institutions and regulators to measure risk.
According to the economists, if financial institutions fail to include crypto-related risks, then the models used to measure risks will misjudge the exact amount of risk.
Therefore, the team proposed the idea of splitting crypto into two categories:
Pegged assets – stablecoins designed to track the price of another asset like USD.
Floating/unpegged cryptos – cryptocurrencies whose prices are based on the market.
Why does crypto need two categories?
As mentioned, economists basically point out that floating crypto is risky, volatile, and unstable, and this can affect the calculation of initial margin requirements in derivatives markets.
This can mostly happen in uncleared markets, meaning derivative trades that are not cleared via a central organization like the Chicago Mercantile Exchange.
Such derivative trades are typically conducted over-the-counter or between two parties, devoid of a central clearinghouse.
Traders who are active in the crypto-based derivatives market might need to put more margin/collateral to back the safety deposit because the crypto price can easily rise and fall. Adding extra collateral also means protecting the party on the other side of the derivatives contract and reducing the risk of a huge financial catastrophe in the wake of a sudden price crash.
Meanwhile, pegged crypto or stablecoins are generally less volatile and require lower margin/collateral requirements. If all cryptocurrencies are treated the same, volatile floating crypto might be misjudged in risk, and pegged assets might be overcharged for collateral.
