How Do Smart Contracts Potentially Mitigate Settlement Risk for Decentralized Derivatives?
Smart contracts can hold collateral in escrow and automatically execute the final transfer of assets or payments upon the expiration or exercise of the derivative, provided all conditions are met. This automation eliminates the human element of potential default during settlement.
The rules are codified and transparent on the blockchain, reducing counterparty and operational risk.
Glossar
Smart Contracts
Function ⎊ Smart contracts are self-executing agreements with the terms of the agreement directly written into lines of code, residing on a decentralized ledger.
Decentralized Autonomous Organization
Governance ⎊ Decentralized Autonomous Organizations represent a novel framework for coordinating collective action, particularly relevant within cryptocurrency ecosystems and increasingly, financial derivatives markets.
Legal Recourse
Remedy ⎊ Providing a means for investors to seek compensation for losses caused by fraud or negligence is essential for maintaining trust in the financial system.
Decentralized Derivatives
Architecture ⎊ Decentralized derivatives represent a fundamental shift in financial contract design, moving away from centralized exchanges and intermediaries towards blockchain-based systems.
Settlement Risk
Exposure ⎊ Settlement risk in cryptocurrency, options, and derivatives arises from the failure of a counterparty to fulfill contractual obligations post-trade, specifically during the settlement period.
Escrow
Custody ⎊ Escrow functions as a conditional custody arrangement within cryptocurrency, options trading, and financial derivatives, mitigating counterparty risk by holding assets until predefined contractual obligations are met.