FEDS paper proposes distinct crypto risk class for uncleared markets
A Federal Reserve Finance and Economics Discussion Series (FEDS) paper proposes classifying cryptocurrencies into a distinct risk class within the ISDA Standardized Initial Margin Model (SIMM) framework. The research suggests splitting this class into pegged and floating cryptocurrencies for uncleared markets.
A new framework for digital assets
A recent Finance and Economics Discussion Series (FEDS) paper from the Federal Reserve proposes a novel classification for cryptocurrency risks within the ISDA Standardized Initial Margin Model (SIMM) framework.
The research, authored by Anna Amirdjanova, David Lynch, and Anni Zheng, specifically examines the calculation of initial margin for trades sensitive to cryptocurrency risk factors in the uncleared market.
The authors conclude that cryptocurrencies, due to their fundamental reliance on distributed ledger technology (DLT) and distinct financial risk profiles compared to traditional asset classes like commodities or foreign exchange, warrant a separate risk class within SIMM.
This new classification is further refined by splitting cryptocurrencies into two distinct buckets: pegged and floating (unpegged) digital assets.
The paper also suggests a methodology for calibrating risk weights within this proposed cryptocurrency risk class, ensuring consistency with existing approaches already adopted in SIMM.
Bridging the gap in risk models
The impetus for this proposed classification stems from the recognition that financial risks inherent in cryptocurrencies differ significantly from those traditionally covered by SIMM.
Current models, designed for established asset classes, may not adequately capture the unique volatility, liquidity, and counterparty risks associated with digital assets.
By advocating for a distinct risk class, the FEDS paper aims to bridge this gap, providing a more robust and accurate method for financial institutions to calculate initial margin.
This is particularly crucial for uncleared markets, where bilateral exposures can pose systemic risks if not properly managed.
The framework integrates evolving digital asset risks into established financial risk management practices.
A necessary distinction
This research provides a crucial step towards integrating digital asset risks into mainstream financial stability frameworks.
While the proposed classification is technically sound, its practical implementation will require significant industry coordination and data standardization.
The paper highlights the urgent need for robust risk management in the rapidly evolving cryptocurrency landscape, offering a pragmatic path forward for regulators and market participants.