Counterparty Risk

The risk that the other party in a financial arrangement fails to meet their obligations, resulting in a loss. In crypto, counterparty risk exists when you trust a centralized entity with your funds, such as a centralized exchange, custodian, or lending platform. DeFi protocols aim to reduce counterparty risk by replacing trusted intermediaries with transparent smart contracts, though they introduce smart contract risk instead. The collapse of FTX in 2022 was a major counterparty risk event.