How Does the Concept of “Rehypothecation” Relate to the Custody of Collateral in Derivatives Trading?

Rehypothecation is the practice where a broker or custodian uses a client's collateral (assets pledged as margin) for its own purposes, such as collateralizing its own loans. While common in traditional finance, it introduces significant risk for the client.

In crypto derivatives, clear rules against rehypothecation are crucial to ensure the collateral remains segregated and available to the client, especially for physically-settled contracts where the asset is the final delivery mechanism.