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Auditing decentralized finance

Author

Listed:
  • Bhambhwani, Siddharth M.
  • Huang, Allen H.

Abstract

Decentralized finance (DeFi), which executes financial transactions using blockchain without an intermediary, has attracted over US$250 billion in total value locked (TVL) at its peak. However, little is known about how DeFi protocols assure users of the safety of their investments. This paper provides the first empirical evidence on DeFi audit services that check and verify the smart contracts underlying these protocols. Using data on 316 of the largest protocols, we find that those vetted by more smart contract auditors and by higher quality auditors have higher TVL and that these protocols have higher market capitalization (native token values). Using an event study approach, we document that TVL and token values significantly increase after a protocol's first audit, especially those involving a high-quality auditor. We also find that protocols with more auditors and higher audit quality exhibit a smaller drop in TVL and token values after the collapse of the TerraUSD stablecoin, which reduced aggregate DeFi TVL by almost 65%. Overall, our findings suggest that DeFi users and investors perceive audits as providing assurance regarding the safety of their deposits and investments.

Suggested Citation

  • Bhambhwani, Siddharth M. & Huang, Allen H., 2024. "Auditing decentralized finance," The British Accounting Review, Elsevier, vol. 56(2).
    • Handle: RePEc:eee:bracre:v:56:y:2024:i:2:s0890838923001270
    DOI: 10.1016/j.bar.2023.101270
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    More about this item

    Keywords

    Blockchain; Cryptocurrency; DeFi; Ethereum; Smart contracts;
    All these keywords.

    JEL classification:

    • M42 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Auditing
    • K22 - Law and Economics - - Regulation and Business Law - - - Business and Securities Law
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • M13 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - New Firms; Startups
    • M15 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - IT Management

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