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Decentralized Finance: On Blockchain- and Smart Contract-Based Financial Markets

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  • Fabian Schär

Abstract

The term decentralized finance (DeFi) refers to an alternative financial infrastructure built on top of the Ethereum blockchain. DeFi uses smart contracts to create protocols that replicate existing financial services in a more open, interoperable, and transparent way. This article highlights opportunities and potential risks of the DeFi ecosystem. I propose a multi-layered framework to analyze the implicit architecture and the various DeFi building blocks, including token standards, decentralized exchanges, decentralized debt markets, blockchain derivatives, and on-chain asset management protocols. I conclude that DeFi still is a niche market with certain risks but that it also has interesting properties in terms of efficiency, transparency, accessibility, and composability. As such, DeFi may potentially contribute to a more robust and transparent financial infrastructure.

Suggested Citation

  • Fabian Schär, 2021. "Decentralized Finance: On Blockchain- and Smart Contract-Based Financial Markets," Review, Federal Reserve Bank of St. Louis, vol. 103(2), pages 153-174, April.
  • Handle: RePEc:fip:fedlrv:91428
    DOI: 10.20955/r.103.153-74
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    References listed on IDEAS

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    More about this item

    Keywords

    blockchain; financial markets;

    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • E59 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Other

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