Counterparty Risks

Counterparties in OTC or secondary markets may fail to deliver locked tokens or other assets due to operational failures, insolvency, or fraudulent activity.

Discrepancies between promised and delivered token allocations may occur, especially in deals involving vesting schedules or future unlocks.

Centralized exchanges (CEX) used for perpetual futures trading may introduce risk if they fail operationally, are insolvent, or engage in unethical practices.

Risk arises from delays or failures in settling trades, transferring funds, or liquidating positions.

Custodians used for triparty escrow in OTC deals or for the safekeeping of collateral may fail to uphold their obligations.

Risks include operational failure, insolvency, or non-compliance with regulatory requirements.

Counterparty risk is amplified in jurisdictions with weak legal systems, unclear enforcement mechanisms, or poor investor protections.

Cross-border transactions may involve additional complexities, such as inconsistent regulatory frameworks or geopolitical risks.

In collateralized OTC transactions, counterparty risk extends to the collateral offered by the counterparty. If the collateral loses value or cannot be liquidated, the protocol may face losses.

• Rigorous Vetting Process: All counterparties undergo a thorough assessment process that includes:
  • AML/KYC Compliance: Ensuring counterparties meet anti-money laundering (AML) and know-your-customer (KYC) requirements.
  • Financial Health Analysis: Evaluating the financial stability and solvency of counterparties, including their balance sheets and historical performance.
  • Operational Reliability: Assessing the counterparty's operational track record, including their ability to deliver assets on time and fulfill contractual obligations.
  • Market Reputation: Reviewing the counterparty's reputation in the industry, including references from trusted parties and past deal performance.
• Red Flags and Exclusions: Counterparties with a history of defaults, disputes, or unethical behavior are excluded from transactions.

• Triparty Escrow Agreements: Wherever possible, OTC deals are structured using qualified custodians as escrow agents. These custodians act as intermediaries to ensure that locked tokens are delivered as agreed. Escrow mechanisms reduce counterparty risk by holding funds or assets in a neutral third-party account until all conditions of the transaction are met.
• Smart Contract Enforced Vesting: For token deals with vesting schedules, smart contracts are used to enforce the delivery of tokens. Smart contracts ensure that delivery is automated and trustless, reducing the risk of manual intervention or fraud.
• Collateralized Transactions: In cases where escrow or smart contracts are not viable, deals are structured as collateralized transactions. Counterparties are required to post collateral (e.g., stablecoins, BTC, or ETH) that can be liquidated in the event of non-delivery or default.

• Transaction Diversification: The protocol avoids concentrated exposure to any single deal or counterparty. OTC transactions are distributed across multiple counterparties and token issuances to minimize the impact of a single default.

• Enforceable Agreements: All OTC transactions are governed by legally binding agreements that clearly define the terms, conditions, and obligations of both parties. Agreements include provisions for dispute resolution, penalties for non-compliance, and performance guarantees.
• Recourse Mechanisms: Contracts are designed to provide legal recourse in the event of a counterparty default. This includes access to arbitration or litigation in reputable jurisdictions.
• Choice of Jurisdiction: Transactions are structured under legal frameworks in jurisdictions with strong investor protections and enforceable contract laws.

• Real-Time Monitoring: Counterparty performance is monitored in real-time to detect early signs of default, such as delays in delivery or changes in financial health. Alerts are triggered for anomalies, allowing the protocol to take proactive measures.
• Contingency Plans: Predefined contingency plans are in place for counterparty defaults, including liquidating posted collateral to cover losses, transitioning deals to alternative counterparties or custodians, and adjusting portfolio allocations to reduce reliance on high-risk counterparties.

• Custodian Vetting: Custodians used for escrow or collateral management undergo the same rigorous vetting process as other counterparties. This includes assessments of their operational capabilities, security protocols, and financial stability.
• Segregated Accounts: Assets held by custodians are kept in segregated accounts to ensure they are not commingled with the custodian's own assets. Segregation protects the protocol's assets in the event of custodian insolvency.