Counterparty risk is the probability that the other party in an investment, credit, or trading transaction may not fulfill its part of the deal and may default on the contractual obligations.
Example: Fiat Currency, weather its US dollars, British Pounds, the Euro, Swiss Franc, etc. these are all promises by a government or group of governments to make good on the value of what is written on a piece of paper, coin, or digital amount in your account. These are what is referred to as inconvertible money, which means they cannot be redeemed for gold or silver. What happens if/when a government can no longer make good? What happens if others loose faith in the government guarantee in the specific currency you hold? Simple its value diminished and, in many cases, does so fast, in a spectacular way that devastates the holders of that currency. Here are some examples in recent history: https://www.investopedia.com/articles/personal-finance/122915/worst-hyperinflations-history.asp
Additional definition of Counter party risk:
Counterparty risk is the risk that the other party in a financial transaction may default on its obligations, leaving the investor with losses or other negative consequences. In other words, it’s the risk that one party in a financial transaction will not hold up its end of the bargain, leaving the other party exposed to potential losses and broken promises.
Counterparty risk can arise in a variety of financial transactions, such as loans, swaps, derivatives, and other complex financial instruments. For example, in a credit default swap, one party agrees to pay the other party a premium in exchange for protection against the default of a particular bond or other financial instrument. If the bond defaults and the counterparty is unable to fulfill its obligations, the investor who purchased the credit default swap could be exposed to significant losses. It like if you bought car insurance, then got into an accident, you go to the insurance company to pay for the repair but they cant pay and close down. Now your stuck with a damaged car with no money to repair it even though you paid for the coverage.
Counterparty risk is an important consideration in financial transactions, and investors should take steps to mitigate their exposure to this risk. This can include carefully selecting counterparties, diversifying investments, and using other risk management strategies. It’s also important to carefully consider the terms of any financial transaction and to fully understand the risks involved before entering the transaction.