How Does a Smart Contract Reduce “Counterparty Risk” in a Derivative?
A smart contract reduces counterparty risk by acting as a trustless escrow agent. Both parties' collateral is locked within the contract.
The contract automatically executes the payoff based on predefined, objective market conditions, eliminating the risk of one party defaulting on their obligation.
Glossar
Operational Risk
Framework ⎊ Operational risk within cryptocurrency, options trading, and financial derivatives transcends traditional financial definitions, demanding a framework that explicitly incorporates technological, regulatory, and idiosyncratic elements.
Decentralized Lending
Service ⎊ Decentralized Lending is the practice of borrowing and lending assets directly through automated, non-custodial smart contracts, eliminating traditional financial intermediaries and relying on algorithmic collateralization for security.
Traditional Finance
Comparison ⎊ Traditional Finance refers to the established, regulated global system of financial intermediation, including centralized exchanges, custodians, and clearinghouses, which provides the conceptual and structural backdrop against which novel crypto derivatives markets are often compared.
Trustless Escrow
Mechanism ⎊ Trustless Escrow is a Mechanism where a smart contract, deployed on a blockchain, automatically holds and manages assets or collateral for a financial transaction, such as a derivative trade, without requiring a human intermediary.
Counterparty Risk
Exposure ⎊ Counterparty risk represents the potential loss incurred when a trading partner defaults on their contractual obligations.
Liquidation Process
Process ⎊ The liquidation process, within cryptocurrency, options, and derivatives, represents the enforced conversion of assets into cash to satisfy outstanding obligations, typically triggered by margin calls or insolvency events.