Crypto Derivatives Spur Regulator Warning as Goldman Dives In

Banks should be careful before getting involved in trading Bitcoin-linked futures and other crypto-derivative products, acting Comptroller of the Currency Michael Hsu said.

Big banks, including Goldman Sachs Group Inc., are looking to make markets in crypto-linked derivative products for their clients even though global financial regulators are still evaluating capital levels that would be needed to safely manage crypto exposures, Hsu said.

Crypto-linked derivatives pose unique problems—including limited price histories, miscalculated hedging and heightened wrong-way risks—that banks need to account for before getting deep into crypto derivatives, Hsu said Thursday at an American Bankers Association risk conference.

“Before banks move too much farther down this path, they should carefully consider the tail risks of trading crypto derivatives,” he said.

Goldman Sachs on March 21 became the first major U.S. bank to offer over-the-counter crypto options trading in conjunction with Galaxy Digital Holdings Ltd., a crypto financial services firm founded by a former Goldman partner, Michael Novogratz.

Options can be used to hedge against risks or boost yields, with over-the-counter trades typically being large and negotiated in private.

Because crypto assets don’t have a long price history, banks may end up not setting aside sufficient capital to cover the risks to their crypto positions, Hsu warned.

At the same time, the netting of crypto risks—a method of reducing risks by combining or aggregating multiple financial obligations—could give a bank too much confidence that it has strong enough hedges in place, Hsu said.

The acting comptroller pointed to several historic blowups, like the 1998 demise of Long-Term Capital Management and the 2012 London Whale trading incident that triggered a $6.2 billion loss for JPMorgan Chase & Co. Banks thought they’d sufficiently hedged their positions to make the risks manageable—only to run into a crisis, he said.

Hsu said that crypto derivatives pose a classic “wrong-way” risk, where investors who are long crypto will increase their positions at the same time that the value of underlying crypto assets fall, Hsu said.

Banks can mitigate their risks by having investors post collateral “unless banks choose to accept crypto-assets as collateral, in which case the value of that collateral would fall at exactly the time that it would be needed most,” he said.