Counterparty Risk

Counterparty risk is the risk that the other party in a transaction will fail to meet their obligations. Some types of transactions suffer additional counterparty risk because there are more than two parties involved. For example, if you hold a certificate of deposit for a precious metal and you sell that to someone, there are at least three parties in that transaction: the seller, the buyer, and the custodian of the precious metal. Someone holds the physical asset; by necessity they become party to the fulfillment of the transaction and add counterparty risk to any transaction involving that asset. In general, when an asset is traded indirectly through the exchange of a token of ownership, there is additional counterparty risk from the custodian of the asset. Do they have the asset? Will they recognize (or allow) the transfer of ownership based on the transfer of a token (such as a certificate, deed, title, or digital token)? In the world of digital tokens representing assets, as in the nondigital world, it is important to understand who holds the asset that is represented by the token and what rules apply to that underlying asset.