What Happens in a Decentralized Options Market If a Large Number of Contracts Are In-the-Money and There Is Insufficient Collateral?

This scenario is known as a "bank run" or a solvency crisis and is a critical risk for a decentralized options protocol. If a large, sudden price move causes many options to become in-the-money simultaneously, the demand to withdraw collateral might exceed the total collateral available in the system, especially if the protocol is not fully collateralized.

This could lead to a failure to settle contracts, a loss of user funds, and a collapse of the protocol's peg or value. To prevent this, most protocols rely on heavy over-collateralization and automated liquidation mechanisms to close risky positions before they can threaten the system's solvency.