What is counterparty risk?
In one line: Counterparty risk is the chance that the other side of a trade or deal, such as a broker or exchange, can't pay you what you're owed.
A simple example
You have $3,000 at a broker or exchange. Your trades are going fine. Then the firm runs out of money because it misused customer funds.
Your trades were right. But the firm holding your money is the problem. That's counterparty risk.
This happened at a large scale in November 2022, when the FTX crypto exchange collapsed and customers couldn't withdraw. The story is in the FTX crash.
Where it shows up
- Brokers: with many retail forex and CFD trades, the broker is the other side of your trade.
- Crypto exchanges: if your coins sit on an exchange, you rely on that exchange to be solvent and honest.
- Bank deals: two firms trading privately rely on each other to pay.
Exchange-traded stocks, options and futures carry much less of it, because a Clearing house stands in the middle.
Ways to reduce it
- Use regulated firms. In the US, stock brokers are overseen by the SEC and FINRA; forex dealers and futures brokers by the CFTC and NFA.
- Know what protection applies. SIPC covers up to $500,000 per customer at a failed member broker, including up to $250,000 in cash. It doesn't cover market losses. More at investor.gov.
- For crypto, learn self-custody vs exchange.
- Don't keep more on any one platform than you need for trading.
Why it matters
A good process protects you from bad trades. It can't protect you from a bad firm. Choosing where you trade is part of managing risk. Ask whether a small saving is worth the extra exposure.
A common mistake
Picking a broker only for low fees or high leverage. Offshore firms that offer huge Leverage often sit outside US rules. If they fail, getting your money back can be hard or impossible.
If a platform promises guaranteed returns or makes withdrawals slow and difficult, treat that as a warning sign.
Questions
What is an example of counterparty risk?
An exchange or broker failing while holding your money, like FTX in 2022.
Does SIPC protect against trading losses?
No. SIPC helps when a member broker fails and customer assets are missing. It doesn't cover losses from prices moving.
Do futures have counterparty risk?
Much less than private deals, because the clearing house guarantees both sides. Your futures broker's health still matters.
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