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Debt-Financed Collateral and Stability Risks in the DeFi Ecosystem

Author

Listed:
  • Michael Darlin
  • Georgios Palaiokrassas
  • Leandros Tassiulas

Abstract

The rise of Decentralized Finance ("DeFi") on the Ethereum blockchain has enabled the creation of lending platforms, which serve as marketplaces to lend and borrow digital currencies. We first categorize the activity of lending platforms within a standard regulatory framework. We then employ a novel grouping and classification algorithm to calculate the percentage of fund flows into DeFi lending platforms that can be attributed to debt created elsewhere in the system ("debt-financed collateral"). Based on our results, we conclude that the wide-spread use of stablecoins as debt-financed collateral increases financial stability risks in the DeFi ecosystem.

Suggested Citation

  • Michael Darlin & Georgios Palaiokrassas & Leandros Tassiulas, 2022. "Debt-Financed Collateral and Stability Risks in the DeFi Ecosystem," Papers 2204.11107, arXiv.org, revised Jun 2022.
    • Handle: RePEc:arx:papers:2204.11107
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    References listed on IDEAS

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    1. Bengt Holmstrom, 2015. "Understanding the role of debt in the financial system," BIS Working Papers 479, Bank for International Settlements.
    2. Gary Gorton, 2008. "The panic of 2007," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 131-262.
    3. Halling, Michael & Yu, Jin & Zechner, Josef, 2016. "Leverage dynamics over the business cycle," Journal of Financial Economics, Elsevier, vol. 122(1), pages 21-41.
    4. Gary Gorton, 2008. "The panic of 2007," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 131-262.
    5. Glasserman, Paul & Young, H. Peyton, 2016. "Contagion in financial networks," LSE Research Online Documents on Economics 68681, London School of Economics and Political Science, LSE Library.
    6. Paul Glasserman & H. Peyton Young, 2016. "Contagion in Financial Networks," Journal of Economic Literature, American Economic Association, vol. 54(3), pages 779-831, September.
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    Cited by:

    1. Aufiero, Sabrina & Forer, Preben & Vivo, Pierpaolo & Caccioli, Fabio & Bartolucci, Silvia, 2025. "Phase transitions in debt recycling," Journal of Economic Dynamics and Control, Elsevier, vol. 171(C).
    2. Cameron MacDonald & Laura Zhao, 2022. "Stablecoins and Their Risks to Financial Stability," Discussion Papers 2022-20, Bank of Canada.
    3. Al Mamoon, Abdullah, 2025. "A review of centralised finance (CeFi) and decentralised finance (DeFi) and its challenges to the lending market," EconStor Preprints 323253, ZBW - Leibniz Information Centre for Economics.
    4. Georgios Palaiokrassas & Sandro Scherrers & Iason Ofeidis & Leandros Tassiulas, 2023. "Leveraging Machine Learning for Multichain DeFi Fraud Detection," Papers 2306.07972, arXiv.org.

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