Counterparty risk has never been as prevalent in crypto as it is right now.
Blockchain can provide transparency for transactions, but visibility into the companies or individuals on the other side of transactions or those holding your assets remains relatively opaque (in terms of how they operate or who they operate with).
Avoiding crypto counterparty risk altogether is extremely difficult when it comes to trading or transacting in digital assets. The best way to minimize counterparty risk is doing as much operational due diligence as you can on who your counterparties are and what their own internal security and operational policies are, and then determining what level of counterparty risk you are comfortable with accepting.
These are some of the biggest crypto counterparty risks to avoid in the markets today:
Transaction settlement and addresses updates with trading partners
Whether you’re dealing with an OTC desk or a market maker, there will always be some form of crypto counterparty risk when it comes to trading partners. The two biggest counterparty risks in this area are not being able to settle a transaction and the use of out-dated deposit addresses.
Not being able to settle a transaction is always a risk when dealing with a counterparty, especially when you consider how fast crypto markets move, the opacity around reporting, and the potential for lax risk management by some actors. To combat this, being able to settle as quickly as possible, even instantaneously, is critically important.
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The use of out-dated deposit addresses is not talked about enough but if either side (the trading partner or yourself) updates a whitelisted crypto deposit address and does not communicate this to the other party, funds can be lost or caught up in a lengthy operations mess. Each counterparty needs to have clear, well-documented policies around the communication of address changes.
Security and use of funds with trading venues
Trading venues, such as exchanges, can be convenient places to keep your keys for a variety of reasons – mostly because it is where you are likely transacting most. However, there are well-documented crypto counterparty risks with this approach (such as exchange hacks, phishing attempts, etc.). Also, given the market turbulence and headlines recently around inappropriate usage of user funds, it can be unclear if a trading venue has taken inappropriate actions with customer funds and how much potential business continuity risk there is.
To combat these potential security and business continuity risks, we recommend not keeping more assets than necessary with trading venues and ensuring there are firm crypto policies in place for sweeping un-needed funds back to in-house wallets.
Business continuity with custodians
Custodians are considered the guardians of crypto keys and are supposed to have the appropriate security and crypto policies in place to fully safeguard your keys at all times. While they are not immune to hacks or security incidents, they are generally very secure. However, they can be susceptible to mergers and acquisitions which presents crypto counterparty risks in the form of business continuity –namely potential changes to operating policies and resources.
While there is no “one size fits all” custodial model, it is best that you have a custody stack that allows you to work as securely and efficiently as possible while also mitigating as much of the business continuity risk as possible.