How Is Counterparty Risk Mitigated in Smart Contract-Based Derivatives?

Smart contract-based derivatives mitigate counterparty risk by removing the need to trust a central counterparty. Instead, trust is placed in the code of the smart contract, which is transparent and executes automatically.

These contracts require parties to lock collateral into the contract upfront. The smart contract then manages this collateral, automatically liquidating positions if they become undercollateralized.

This ensures that obligations are met without relying on the solvency or honesty of the trading partner.