Counterparty is an open source, decentralized protocol built directly on top of the Bitcoin Blockchain that allows for the creation of digital asset tokens, smart contracts, and a decentralized exchange (DEx). While projects like Colored Coins offer the creation of tokenable assets with Bitcoin, only Counterparty offers smart contract functionality and the DEx.
While it is seemingly underrated, the Counterparty DEx is potentially a 'killer app' for Bitcoin because it allows for the peer-to-peer trading of any tokenized value on a completely decentralized network without the need of a third party. The founders of CP did not name their protocol Counterparty because it sounded cool. Counterparty is aptly named because it a counterparty that functions without central control, without a third party to facilitate the escrow of a trade.
The trading and settlement of financial instruments like securities and derivatives is currently done through the use of various counterparties, such as a clearing house. Banks settle currency and security trades through similar settlement organizations, such as foreign exchange markets. The use of these intermediaries is necessary and an integral part of the global financial system.
The Bitcoin Blockchain, with the help and features of the Counterparty protocol, can act as a clearinghouse for the final settlement of securities. If Bank of America wanted to exchange 1000 BOADOLLARS for 900 of the Bank of England's BOEPOUNDS, Bank of America would list the order on the DEx, where the Bank of England could fulfill the order. The trade of 1000 BOADOLLARS for 900 BOEPOUNDS is executed on the DEx - the Blockchain is the only counterparty in this transaction.
Even better, the trading of VALUEONE for VALUETWO can be conducted directly on the DEx between two parties that are unknown to each other - the trade doesn't require trust.
This trustless exchange ultimately reduces counterparty risk, which is the financial risk assessment of a counterparty in an exchange. In the above example, both Bank of America and the Bank of England are able to settle that trade through a system that will cost no more than a miner's fee on the Blockchain.
Is the DEx in this example the best solution for banks settling value with each other? That remains unknown, as both BoA and the BoE operate in an efficient banking system in a matured financial infrastructure. But what if a sanctioned bank in Iran wanted to settle value with a financial organization in China? An uncensorable DEx might be their best solution, and they could execute this trade with reduced regulatory risk.
The financial world using the DEx for inter-settlement trade would disrupt current clearing house and settlement infrastructure and reduce costs for all exchanging parties.