How Does the Collateralization Mechanism in a Smart Contract-Based Options Protocol Ensure Solvency?
The protocol ensures solvency by requiring option writers to lock sufficient collateral into the smart contract to cover their potential obligations. The contract's logic continuously monitors the value of the collateral relative to the risk of the written options.
If the collateral value drops too low, the contract may trigger a liquidation or margin call, ensuring the system remains fully backed and able to pay out option holders.
Glossar
Solvency
Assessment ⎊ Solvency refers to the financial state where an entity possesses sufficient assets to cover its long-term liabilities.
Collateralization Mechanism
Framework ⎊ The collateralization mechanism, within cryptocurrency derivatives, options trading, and broader financial derivatives, establishes a system where assets are pledged as security against potential losses arising from contractual obligations.