What Is the Role of a Central Counterparty (CCP) and How Might DLT Replace or Augment It?
A CCP steps between the buyer and seller of a derivatives contract, becoming the buyer to every seller and the seller to every buyer. This guarantees the trade, reducing counterparty risk.
DLT can augment a CCP by automating post-trade processing and collateral management. Alternatively, a decentralized protocol using smart contracts and on-chain collateral can potentially replace some CCP functions by trustlessly guaranteeing settlement and managing risk directly on the ledger.
Glossar
On-Chain Collateral
Security ⎊ On-chain collateral refers to digital assets locked within a smart contract to secure a financial position, such as a loan or a derivatives trade.
CCP Functions
Clearing ⎊ In cryptocurrency derivatives and options trading, clearing functions, typically performed by a Central Counterparty (CCP), mitigate counterparty credit risk inherent in these markets.
DLT
Architecture ⎊ Distributed Ledger Technology, within cryptocurrency, options trading, and financial derivatives, represents a foundational shift from centralized databases to a replicated, shared, and synchronized digital record across multiple participants.
Decentralized Protocol
Definition ⎊ A Decentralized Protocol refers to a set of codified rules and smart contracts operating on a blockchain, enabling peer-to-peer interactions and financial operations without reliance on a central intermediary or single point of control.
Role of a Central Counterparty
Function ⎊ The role of a central counterparty (CCP) in traditional finance is to act as the intermediary between buyers and sellers in a derivatives transaction, guaranteeing settlement and mitigating counterparty risk.
Smart Contracts
Function ⎊ Smart contracts are self-executing agreements with the terms of the agreement directly written into lines of code, residing on a decentralized ledger.