Does Cash Settlement Eliminate Counterparty Risk?
No, cash settlement does not eliminate counterparty risk entirely, but it significantly mitigates it by centralizing the risk with a clearing house. The clearing house guarantees the trade, reducing the risk of a default by the original counterparty.
However, a residual risk remains: the clearing house itself could default, or the system could fail.
Glossar
Counterparty Risk
Exposure ⎊ Counterparty risk represents the potential loss incurred when a trading partner defaults on their contractual obligations.
Cash Settlement
Settlement ⎊ Cash settlement, within cryptocurrency derivatives and options trading, represents the fulfillment of a contract obligation through a monetary exchange rather than physical delivery of the underlying asset.
Clearing House
Settlement ⎊ A clearing house, within cryptocurrency and derivatives markets, functions as an intermediary between buyers and sellers, mitigating counterparty risk through a process of novation ⎊ replacing original trade agreements with new ones directly with the clearing house.