How Does Counterparty Risk Differ between Custodial and Non-Custodial Exchanges? ⎊ Path

How Does Counterparty Risk Differ between Custodial and Non-Custodial Exchanges?

On a custodial exchange, counterparty risk is concentrated on the exchange itself. If the exchange becomes insolvent or suffers a security breach, users can lose their funds because the exchange holds their assets.

For non-custodial exchanges, the risk is shifted from a central entity to smart contracts. While this eliminates the risk of the exchange failing, it introduces smart contract risk, where a bug or exploit in the code could lead to a loss of funds.

Users do not face the risk of the exchange itself being a failing counterparty.

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Glossar

Custodial Exchange

Model ⎊ Custodial Exchange describes a centralized entity that takes possession and control of user funds to facilitate trading, operating similarly to a traditional brokerage but within the digital asset domain.

Counterparty Risk

Exposure ⎊ Counterparty risk represents the potential loss incurred when a trading partner defaults on their contractual obligations.