UAE: A Potential Home For Crypto Derivatives

Crypto derivatives offer several benefits to market participants. One advantage is that they allow individuals to gain exposure to the asset class without needing to hold the physical assets themselves. This eliminates the complexities of managing wallets and other market infrastructure. Additionally, trading with regulated counterparties provides a safer environment for new participants entering the market.

However, there are also drawbacks associated with crypto derivatives, many of which are related to the nature of the underlying crypto assets. Price volatility and market risk are major concerns, as crypto markets are known for their high volatility. The 24-hour trading nature of cryptocurrencies also poses challenges, requiring robust risk controls to manage potential risks. Furthermore, unexpected technology or protocol changes can impact the performance and functionality of crypto derivatives.

The perceived benefits and drawbacks of crypto derivatives vary depending on the perspective and background of the investor. Crypto-native firms are often more interested in the products themselves, while financial institutions prioritise risk management for their clients.

One notable feature of the crypto market is the lack of traditional market infrastructure, such as centralised exchanges and shared valuation protocols. However, it also offers new means of managing credit risk through technologies that provide real-time portfolio valuations. The legal status of cryptocurrencies as a form of property has been recognised in many legal systems, but certain aspects, such as their classification for financial collateral arrangements, are still being resolved.

Existing documentation does not readily accommodate cryptocurrencies as reference assets. As a result, market participants rely on a combination of commodity and equity definitions, along with bespoke terms. Standardising the legal documentation for crypto derivatives is essential for a more mature and standardised trading infrastructure in the market. This process aligns with the ongoing movement towards digitalisation of documents, which offers benefits such as reduced errors, easier interpretation, and automation of contracts.

Regulatory vagueness has been a huge stumbling block for companies looking to develop these kinds of products. Certainly, the ADGM in the UAE has made specific mention of crypto derivatives in its virtual asset framework and provides a sophisticated regulatory environment and sandbox for the development, exploration and deployment of such products on the market.