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Grasping decentralized finance through the lens of economic theory

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  • Jonathan Chiu
  • Charles M. Kahn
  • Thorsten V. Koeppl

Abstract

In this viewpoint article, we provide an analysis of the value proposition of decentralized finance (DeFi) and its limitations using a simple stylized model of collateralized lending. DeFi uses a decentralized ledger to run smart contracts that automatically enforce the terms of a lending contract and safeguard the collateral. DeFi can lower the costs associated with intermediated lending and improve financial inclusion. Limitations are the volatility of crypto collateral and stablecoins used for settlement, the possible incompleteness of smart contracts and the lack of a reliable oracle. A proper infrastructure reducing such limitations could improve the value of DeFi. Comprendre la finance décentralisée dans l'optique de la théorie économique. Dans cet article d'opinion, nous présentons une analyse de la proposition de valeur de la finance décentralisée et de ses limites à l'aide d'un simple modèle stylisé (DeFi pour decentralized finance) de prêts assortis de garanties. DeFi utilise un grand livre décentralisé pour exécuter des contrats intelligents qui applique automatiquement les conditions d'un contrat de prêt et sécurise la garantie financière. DeFi peut diminuer les coûts associés au financement par intermédiaire et améliorer l'inclusion financière. Les limites sont la volatilité des cryptoactifs affectés en garantie et des cyberjetons indexés utilisés pour le règlement, la possibilité que les contrats intelligents soient incomplets et l'absence d'un modèle physique de données fiable. Une infrastructure adéquate qui réduit ces limites pourrait améliorer la valeur de DeFi.

Suggested Citation

  • Jonathan Chiu & Charles M. Kahn & Thorsten V. Koeppl, 2022. "Grasping decentralized finance through the lens of economic theory," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 55(4), pages 1702-1728, November.
    • Handle: RePEc:wly:canjec:v:55:y:2022:i:4:p:1702-1728
    DOI: 10.1111/caje.12627
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    References listed on IDEAS

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    1. Lin William Cong & Zhiguo He, 2019. "Blockchain Disruption and Smart Contracts," The Review of Financial Studies, Society for Financial Studies, vol. 32(5), pages 1754-1797.
    2. Ye Li & Simon Mayer & Simon Mayer, 2021. "Money Creation in Decentralized Finance: A Dynamic Model of Stablecoin and Crypto Shadow Banking," CESifo Working Paper Series 9260, CESifo.
    3. Jonathan Chiu & Thorsten V Koeppl, 2019. "Blockchain-Based Settlement for Asset Trading," The Review of Financial Studies, Society for Financial Studies, vol. 32(5), pages 1716-1753.
    4. Sirio Aramonteand & Wenqian Huang & Andreas Schrimpf, 2021. "DeFi risks and the decentralisation illusion," BIS Quarterly Review, Bank for International Settlements, December.
    5. Agostino Capponi & Ruizhe Jia, 2021. "The Adoption of Blockchain-based Decentralized Exchanges," Papers 2103.08842, arXiv.org, revised Jul 2021.
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    Cited by:

    1. Naudts, Ellen, 2023. "The future of DAOs in finance - in need of legal status," Occasional Paper Series 331, European Central Bank.
    2. Dao Ha & Phuong Le & Duc Khuong Nguyen, 2025. "Financial inclusion and fintech: a state-of-the-art systematic literature review," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 11(1), pages 1-42, December.
    3. Remy Oben & Fezile Özdamlı, 2024. "Decentralized Finance (DeFi): Benefits, Risks, and RiskMitigation Strategies," Istanbul Business Research, Istanbul University Business School, vol. 53(3), pages 455-475, December.
    4. Proelss, Juliane & Sévigny, Stéphane & Schweizer, Denis, 2023. "GameFi: The perfect symbiosis of blockchain, tokens, DeFi, and NFTs?," International Review of Financial Analysis, Elsevier, vol. 90(C).

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    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services

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