Does Cash Settlement Eliminate Counterparty Risk Entirely?
No, cash settlement does not eliminate counterparty risk entirely; it merely shifts and centralizes it. The risk is primarily concentrated on the clearinghouse or the exchange, which guarantees the payment between the buyer and seller.
If the clearinghouse fails, or if a large participant defaults and the clearinghouse's guarantee fund is insufficient, counterparty risk still exists. However, it is generally much lower than in an over-the-counter physically-settled trade.
Glossar
Counterparty Risk
Exposure ⎊ Counterparty risk represents the potential loss incurred when a trading partner defaults on their contractual obligations.
Decentralized Finance
Architecture ⎊ Decentralized Finance, or DeFi, fundamentally reimagines traditional financial infrastructure through blockchain technology, specifically leveraging smart contracts to automate and execute financial agreements without intermediaries.
Clearinghouse
Finality ⎊ A decentralized clearinghouse function provides near-instantaneous transaction finality by acting as the central ledger for trade confirmation and settlement across derivatives.
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.
Guarantee
Assurance ⎊ Within cryptocurrency derivatives and options trading, assurance represents a formalized commitment regarding the performance or outcome of a contract, extending beyond a mere promise.