Does Collateralization Completely Eliminate Counterparty Risk?
No, collateralization significantly reduces, but does not completely eliminate, counterparty risk. Residual risks remain, such as legal risk (if the collateral agreement is unenforceable), liquidity risk (if the collateral is hard to sell), and wrong-way risk (if the counterparty's default risk is correlated with the value of the collateral).
Glossar
Default Risk
Exposure ⎊ Default risk within cryptocurrency derivatives manifests as counterparty credit risk amplified by market volatility and regulatory uncertainty.
Liquidity Risk
Impairment ⎊ Liquidity risk within cryptocurrency, options, and derivatives manifests as the potential for a trader to exit a position at a substantial loss due to insufficient market depth.
Illiquid Tokens
Token ⎊ Illiquid Tokens are cryptocurrency assets characterized by low trading volume, wide bid-ask spreads, and a limited depth of market, making large-scale transactions difficult to execute without significant price impact.
Collateralization
Security Deposit ⎊ Collateralization is the process of securing a financial obligation, particularly in margin trading or lending protocols, by locking up an asset of greater value than the liability being assumed, thereby providing a buffer against potential loss.
Rehypothecation
Practice ⎊ This involves the reuse of collateral that has been posted by one counterparty to secure obligations with a second counterparty, often without explicit notification to the original collateral provider.
Collateral Agreement
Mitigation ⎊ A collateral agreement within cryptocurrency, options, and derivatives functions as a risk transfer mechanism, securing obligations against potential counterparty default or market volatility.