What Happens When a Counterparty Defaults in a Smart Contract-Based Derivative Agreement?
In a smart contract-based derivative, a "default" is typically a situation where a position becomes undercollateralized. The smart contract is programmed to automatically handle this event without manual intervention.
When the collateral value drops below a certain threshold, a liquidation event is triggered. The smart contract allows a third-party liquidator to repay the debt and claim the collateral, often at a discount.
This automated process ensures that the position is closed before it becomes a loss for the protocol, effectively preventing a traditional default scenario.
Glossar
Socialized Loss Mechanisms
Mechanism ⎊ Socialized Loss Mechanisms are predefined protocols, typically activated as a last resort in crypto derivatives markets, designed to distribute unrecoverable losses from an insolvent position across a broader group of solvent market participants.
Counterparty Defaults
Exposure ⎊ Counterparty defaults within cryptocurrency derivatives represent the failure of an entity to meet its contractual obligations, impacting collateralized positions and potentially triggering cascading liquidations.