IDEAS home Printed from https://ideas.repec.org/p/arx/papers/2303.08748.html
   My bibliography  Save this paper

DeFi Lending During The Merge

Author

Listed:
  • Lioba Heimbach
  • Eric Schertenleib
  • Roger Wattenhofer

Abstract

Lending protocols in decentralized finance enable the permissionless exchange of capital from lenders to borrowers without relying on a trusted third party for clearing or market-making. Interest rates are set by the supply and demand of capital according to a pre-defined function. In the lead-up to The Merge: Ethereum blockchain's transition from proof-of-work (PoW) to proof-of-stake (PoS), a fraction of the Ethereum ecosystem announced plans of continuing with a PoW-chain. Owners of ETH - whether their ETH was borrowed or not - would hold the native tokens on each chain. This development alarmed lending protocols. They feared spiking ETH borrowing rates would lead to mass liquidations which could undermine their viability. Thus, the decentralized autonomous organization running the protocols saw no alternative to intervention - restricting users' ability to borrow. We investigate the effects of the merge and the aforementioned intervention on the two biggest lending protocols on Ethereum: AAVE and Compound. Our analysis finds that borrowing rates were extremely volatile, jumping by two orders of magnitude, and borrowing at times reached 100% of the available funds. Despite this, no spike in mass liquidations or irretrievable loans materialized. Further, we are the first to quantify and analyze hard-fork-arbitrage, profiting from holding debt in the native blockchain token during a hard fork. We find that arbitrageurs transferred tokens to centralized exchanges which at the time were worth more than 13 Mio US$, money that was effectively extracted from the platforms' lenders.

Suggested Citation

  • Lioba Heimbach & Eric Schertenleib & Roger Wattenhofer, 2023. "DeFi Lending During The Merge," Papers 2303.08748, arXiv.org, revised Aug 2023.
  • Handle: RePEc:arx:papers:2303.08748
    as

    Download full text from publisher

    File URL: http://arxiv.org/pdf/2303.08748
    File Function: Latest version
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Jiahua Xu & Nikhil Vadgama, 2021. "From banks to DeFi: the evolution of the lending market," Papers 2104.00970, arXiv.org, revised Dec 2022.
    2. Kaihua Qin & Liyi Zhou & Pablo Gamito & Philipp Jovanovic & Arthur Gervais, 2021. "An Empirical Study of DeFi Liquidations: Incentives, Risks, and Instabilities," Papers 2106.06389, arXiv.org, revised Oct 2021.
    3. Lewis Gudgeon & Sam M. Werner & Daniel Perez & William J. Knottenbelt, 2020. "DeFi Protocols for Loanable Funds: Interest Rates, Liquidity and Market Efficiency," Papers 2006.13922, arXiv.org, revised Oct 2020.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Cornelli, Giulio & Gambacorta, Leonardo & Garratt, Rodney & Reghezza, Alessio, 2024. "Why DeFi lending? Evidence from Aave V2," CEPR Discussion Papers 19358, C.E.P.R. Discussion Papers.
    2. Xihan Xiong & Zhipeng Wang & Xi Chen & William Knottenbelt & Michael Huth, 2023. "Leverage Staking with Liquid Staking Derivatives (LSDs): Opportunities and Risks," Papers 2401.08610, arXiv.org, revised Jan 2025.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Raphael Auer & Bernhard Haslhofer & Stefan Kitzler & Pietro Saggese & Friedhelm Victor, 2024. "The technology of decentralized finance (DeFi)," Digital Finance, Springer, vol. 6(1), pages 55-95, March.
    2. Lioba Heimbach & Eric G. Schertenleib & Roger Wattenhofer, 2023. "Short Squeeze in DeFi Lending Market: Decentralization in Jeopardy?," Papers 2302.04068, arXiv.org, revised Jun 2023.
    3. Son, Jaemin & Ryu, Doojin, 2024. "Competitive dynamics between decentralized and centralized finance lending markets," International Review of Financial Analysis, Elsevier, vol. 96(PB).
    4. Peplluis R. Esteva & Andrés El-Fakdi & Alberto Ballesteros-Rodríguez, 2023. "Invoice Discounting Using Kelly Criterion by Automated Market Makers-like Implementations," Mathematics, MDPI, vol. 11(7), pages 1-37, March.
    5. Estelle Sterrett & Waylon Jepsen & Evan Kim, 2022. "Replicating Portfolios: Constructing Permissionless Derivatives," Papers 2205.09890, arXiv.org, revised Jun 2022.
    6. Teng Andrea Xu & Jiahua Xu, 2022. "A Short Survey on Business Models of Decentralized Finance (DeFi) Protocols," Papers 2202.07742, arXiv.org, revised Jul 2023.
    7. Saengchote, Kanis, 2023. "Decentralized lending and its users: Insights from compound," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 87(C).
    8. Castro-Iragorri, C & Ramírez, J & Vélez, S, 2021. "Financial intermediation and risk in decentralized lending protocols," Documentos de Trabajo 19420, Universidad del Rosario.
    9. Fantacci, Luca & Lorenzini, Marcella, 2024. "Technology versus trust: Non-bank credit systems from notarized loans in Early Modern Europe to cryptolending," Structural Change and Economic Dynamics, Elsevier, vol. 69(C), pages 83-95.
    10. Ghaemi Asl, Mahdi & Ben Jabeur, Sami, 2024. "Tail connectedness of DeFi and CeFi with accessible banking pillars: Unveiling novel insights through wavelet and quantile cross-spectral coherence analyses," International Review of Financial Analysis, Elsevier, vol. 95(PB).
    11. Carlos Castro-Iragorri & Julian Ramirez & Sebastian Velez, 2021. "Financial intermediation and risk in decentralized lending protocols," Papers 2107.14678, arXiv.org.
    12. BELAŞCU Lucian & HOROBEȚ Alexandra & MNOHOGHITNEI Irina, 2022. "Bitcoin is so Last Decade – How Decentralized Finance (DeFi) could Shape the Digital Economy," European Journal of Interdisciplinary Studies, Bucharest Economic Academy, issue 01, March.
    13. Makridis, Christos A. & Fröwis, Michael & Sridhar, Kiran & Böhme, Rainer, 2023. "The rise of decentralized cryptocurrency exchanges: Evaluating the role of airdrops and governance tokens," Journal of Corporate Finance, Elsevier, vol. 79(C).
    14. Yousaf, Imran & Jareño, Francisco & Esparcia, Carlos, 2022. "Tail connectedness between lending/borrowing tokens and commercial bank stocks," International Review of Financial Analysis, Elsevier, vol. 84(C).
    15. Kanis Saengchote, 2022. "Decentralized lending and its users: Insights from Compound," Papers 2212.05734, arXiv.org.
    16. Francesca Carapella & Nathan Swem, 2022. "Decentralized Finance (DeFi): Transformative Potential & Associated Risks," Finance and Economics Discussion Series 2022-057, Board of Governors of the Federal Reserve System (U.S.).
    17. Bhambhwani, Siddharth M. & Huang, Allen H., 2024. "Auditing decentralized finance," The British Accounting Review, Elsevier, vol. 56(2).
    18. Georgios Palaiokrassas & Sandro Scherrers & Iason Ofeidis & Leandros Tassiulas, 2023. "Leveraging Machine Learning for Multichain DeFi Fraud Detection," Papers 2306.07972, arXiv.org.
    19. Massimo Bartoletti & James Hsin-yu Chiang & Alberto Lluch-Lafuente, 2020. "SoK: Lending Pools in Decentralized Finance," Papers 2012.13230, arXiv.org.
    20. Ali, Shoaib & Zhang, Ting & Yousaf, Imran, 2025. "Interlinkage between lending and borrowing tokens and US equity sector: Implications for social finance," Research in International Business and Finance, Elsevier, vol. 73(PA).

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:arx:papers:2303.08748. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: arXiv administrators (email available below). General contact details of provider: http://arxiv.org/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.