The echoes of the FTX collapse continue to reverberate through crypto trading markets, much like the Universe’s cosmic background radiation is the echo of the Big Bang. Over time, the focus on counterparty risk management ebbs and flows, but is always ever-present.
At Crypto Insights Group, counterparty risk management is at least a weekly topic of discussion in speaking with investment managers and allocators alike. Many digital asset managers are still adapting to their fiduciary responsibilities in managing investment portfolios and counterparty relationships, while striving to ensure their strategies can be implemented effectively. Their clients, whether institutional investors or high net worth individuals, are always trying to understand the risks to their books through utilizing third-party investment advisors, via pools such as commingled funds or separately managed accounts.
Then on occasion, when crypto market events like October 10, 2025 happen, those crypto “Big Bang” echoes are no longer faint reverberations, but come crashing back again like the cymbals at the end of a theatrical score.
From decades of experience in traditional securities markets, our team has learned how to implement effective counterparty risk management: From the events of Lehman Brothers failing, and the resulting Global Financial Crisis, where every brokerage, exchange or bank was at risk of collapsing, to the surprise implosion of MF Global, straight through to the events of Mt. Gox and FTX.
From a buy-side perspective, the obvious lesson is counterparty risk will always exist; but an equally important response is, how to effectively manage such risks?
In the Begining… Due Diligence
Engaging any crypto counterparty, be it a broker/dealer, a centralized exchange, a decentralized (DeFi) exchange, a custodian or a bank, should begin with rigorous due diligence. Here one should strive to collect information in various forms, examples of which include:
- Marketing materials and basic web-based information.
- Creating an appropriate due diligence questionnaire (DDQ) for the counterparty to complete; and if available, receiving their self-issued DDQ.
- If the counterparty is subject to any regulation or is registered, searching relevant regulator websites to verify registrations and check for past violations.
- Although rare, but with many recent crypto IPOs announcements, collecting and reviewing public company filings, such as 10-K’s (U.S. SEC filing), 10-Q’s (U.S. SEC filing), Companies House filings (U.K. business filing), independent audits and other public disclosures.
- Ensuring the assets of a fund or SMA are held with the counterparty within a segregated account versus an omnibus account.
Once the above is received, putting all of the information together into a comprehensive report or memo is key to documenting the existing and potential risks of working with a particular counterparty.
For investment managers, best practices are to present such information to relevant internal colleagues, such as portfolio managers, traders and risk managers, and ideally discussed within a governance group such as an investment or risk committee, where the counterparty can be properly evaluated to determine if engagement is to be pursued.
As a fiduciary, a manager should document key service provider engagement decisions so as to keep a record of why a counterparty was chosen.
To Infinity And Beyond… Ongoing Practices and Monitoring
In a way, conducting due diligence and making the determination to engage a counterparty is the easy part. The next step, which is effectively a perpetual process for as long as the counterparty remains an active service provider, includes monitoring, and when necessary, taking corrective actions.
Ongoing monitoring can be iterative based on the assessed risk of the counterparty, but should generally include some of the following exercises, conducted with regular frequency (i.e., monthly):
- Diversification: Although not always an option for trading certain digital assets, but when an option, maintaining counterparty diversification for parts of an investment book with different providers, by separating assets into a custodial account or cold storage wallet. Yes, every counterparty is going to push for all of an account’s business through economies of scale, but a good fiduciary can have sound reasoning for paying a little more for safety.
- Service Levels: If through the course of working with a counterparty an investment manager’s team finds there are persistent errors or other service-level issues, these matters could be an indication that the vendor is creating potential risks to efficiently managing a book, or signs of internal failures that may result in operational risks. Past and recent examples include sell-side firms halting client account withdrawals or not providing good customer service.
- Cybersecurity: Whether it is identified publicly or through due diligence, if a crypto counterparty has disclosed cyber risks where they cannot clearly demonstrate corrective actions or fixes, an investment business should give scrutiny as to whether they want to assume the risk of a third-party’s weak controls. In addition, if a counterparty announces that they will reimburse clients’ accounts for any losses, that doesn’t necessarily address the root cause of what failed.
- Financial Standing: As a vast majority of crypto counterparts are privately owned enterprises, requesting regular updates on reserves and profitability is an important way for a client to understand and assess the ability of the service provider to continue operating in a way that demonstrates stability, as opposed to seeking fresh capital to “keep the lights on.”
Preparing For The Next Big Bang
In working with hundreds of crypto investment managers and their clients, Crypto Insights Group appreciates the standards and requirements of managing capital at an institutional level. Daily operational requirements and client requests abound, and although many managers strive to employ the best internal practices, there are inherent limitations when relying upon key critical service providers, such as a crypto counterparty.
However, engaging a counterparty does not mean one must accept a “take it or leave it” approach to working with sell-side colleagues.
In building an effective counterparty due diligence and oversight program, investment managers and their allocator clients can benefit from assessing risks upfront, using such tools detailed above, both in an initial and an ongoing basis, to ensure fair engagements, and most importantly, to provide the ability to respond quickly to what will certainly be future a “Big Bang.”
CIG & Proactively Managing Counterparty Risk
Crypto Insights Group has the data, benchmarking and due diligence framework to help assess and manage counterparty risk. We provide the expertise of former institutional investors, through rigorous service-provider research and reporting, to meet the fiduciary standards and ongoing expectations of sophisticated crypto investors.
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