What Is Counterparty Risk?
One of the benefits of owning physical gold and silver is there is no counterparty risk.
What exactly is counterparty risk?
In a nutshell, it is the risk that a person or institution on the other side of a transaction might not fulfill their obligation.
For an example, consider government bonds. When you buy a bond, you assume the government will pay interest and return your invested money at the end of the bond’s term. But a government could be overthrown, or it could accumulate so much debt that it can’t repay all of its bondholders. Although it’s unlikely, you could loose your money. That’s the counterparty risk — the possibility that the other party in a transaction won’t follow through on their commitment.
Most investment transactions come with some degree of counterparty risk. When a company issues stock, that company could go bankrupt and the stock could go to zero. If you put money in the bank, the bank could become insolvent. If you rent somebody a car, they could wreck it. Those are just three examples of counterparty risk.
Even government-issued fiat currency has counterparty risk. People who have old Zimbabwe banknotes know this to be true.
Gold and silver have no counterparty risk.
In fact, if you own physical gold or silver, there is no other party involved. No counterparty means no counterparty risk. Precious metals don’t depend on any people or institutions to give them value. Nothing behind gold and silver can fail to render them valueless. In a nutshell, gold and silver are liquid under all market conditions.
When we say gold and silver have no counterparty risk, it’s important to remember that we are talking about physical gold and silver that remains in your possession. If you buy a gold or silver ETF (paper gold and silver), you assume that the issuer of the ETF has the physical metal to back the paper on hand. It may or may not, and that introduces counterparty risk.
You also take on counterparty risk when you store your gold and silver with a third party. It is possible for that third-party storage entity to commit fraud, get robbed, or be destroyed by an act of god. While the counterparty risk introduced by storing your gold and silver with a third party is relatively low, it does exist. You have to weigh that risk against the risk of storing large amounts of metal in your home. You can find reliable third-party storage options HERE.