Counterparty Risk
What Is Counterparty Risk?
Counterparty risk, also known as settlement risk, is a fundamental concept in finance that also applies directly to the cryptocurrency world. It refers to the risk that the person or entity on the other side of a deal (the “counterparty) will default on their part of the bargain.
In simple terms, it’s the risk of not getting what you were promised because the other side fails to deliver. This failure could be due to bankruptcy, insolvency, outright fraud, or some technical issue or error.
While counterparty risk in the crypto space can also refer to a simple peer-to-peer or party-to-party transaction, it’s most referenced in the context of third-party custodial platforms.
How Does Counterparty Risk Work?
Some examples of counterparty risk in crypto include:
Centralized Exchanges (CEXs)
When you leave your crypto on a centralized exchange, the exchange is your counterparty. The risk is that the exchange could get hacked, go bankrupt (like FTX or Mt. Gox), or freeze your account, causing you to lose all your funds.
Lending Platforms
If you lend your crypto to earn interest, your counterparty is the borrower (or the platform itself). The risk is that the borrower defaults on the loan or the platform gets exploited or otherwise loses your funds.
Stablecoins and Wrapped Assets
When holding assets like stablecoins (e.g., USDC, USDT) or wrapped tokens (e.g., wBTC, wETH), you are trusting the issuing entity to maintain the 1:1 backing with the underlying asset (like USD or BTC). If the issuer fails, the stablecoin or wrapped token could lose its value entirely. The most effective way to eliminate counterparty risk in crypto is to practice secure self-custody. By using a signer, you store your private keys offline, ensuring that only you have control over your assets. This removes trusted third partiesfrom the equation, making you the sole owner of your crypto.
