What Is the Significance of Collateralization in a Smart Derivative Contract?

Collateralization is the act of locking assets into the smart contract to secure the potential financial obligation of both parties. It serves as a guarantee that the contract's terms, whether exercise or settlement, will be fulfilled.

This pre-funding mechanism directly mitigates counterparty default risk. If a party's position moves against them, the collateral can be automatically liquidated to cover the loss.

The required collateral amount is often dynamically adjusted based on market volatility.