Linkages between DeFi assets and conventional currencies: Evidence from the COVID-19 pandemic

This paper examines the static and dynamic returns connectedness between four renowned DeFi assets, namely, Chainlink, Maker, Basic Attention Token, and Synthetix, and four internationally important conventional currencies, being they Chinese Yuan, Japanese Yen, Euro, and Pound Sterling. We use the time-varying parameter vector autoregressions framework combined with the connectedness approach based on the generalized forecast error variance decomposition. Our static connectedness analysis evidences a low connection of the DeFi markets with the conventional currency markets. The results of our dynamic analysis reveal that the return spillovers are time-varying, with an abrupt increase in connectedness between the DeFi and currency markets in early 2020, during the initial escalation of the pandemic. However, the spillover from the Chinese Yuan to the system does not exhibit any hike due to the COVID-19-triggered meltdown, highlighting a pandemic-caused decoupling of the Chinese financial system from the other centralized and decentralized markets. We observe unprecedentedly high spillovers from the system to the DeFi markets at the beginning of the pandemic. However, we still find that the DeFi markets act predominantly as net innovation transmitters during the first COVID-19 year. Moreover, we detect the existence of a pairwise-like relationship between the net return spillover profiles and report on inversely symmetric profiles for the Maker - Euro, Basic Attention Token - Japanese Yen, and the Chainlink - Pound Sterling pairs. Given the time-varying transmission-reception patterns for all markets, investors and policymakers can make use of our spillover analysis to improve portfolio allocation and regulatory decisions.