How Do Smart Contracts Reduce Counterparty Risk in Financial Derivatives?

Smart contracts eliminate counterparty risk by holding the collateral or assets in an escrow-like mechanism on the blockchain. The contract's code, which is transparent and immutable, automatically enforces the settlement based on the predefined conditions.

This removes the need for a trusted third party, such as a clearinghouse, as neither party can unilaterally default or alter the terms. This pre-funding and deterministic execution ensures settlement.