How Is Collateral (Margin) Managed and Liquidated in a Decentralized Derivatives Smart Contract?

In a decentralized derivatives contract, both parties lock collateral into the smart contract at the start. The contract uses a price oracle to constantly monitor the value of the collateral.

If a party's position loses value and their margin falls below a required maintenance level, the contract flags the position as undercollateralized. This triggers a liquidation function that allows a third-party liquidator to repay the debt in exchange for a portion of the collateral at a discount.

This automated process ensures the system remains solvent without a central clearing house.