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DeFi Lending: Returns, Leverage, and Liquidation Risk

Author

Listed:
  • Jonathan Chiu
  • Furkan Danisman

Abstract

We study decentralized lending on Aave V3, the largest DeFi lending protocol by total value locked. Using transaction-level data, we analyze its revenue model, borrower behavior, and liquidation dynamics. We find that protocol earnings are concentrated in a few tokens, that many users engage in recursive leverage despite overcollateralization requirements, and that liquidations occur in concentrated waves but have limited impacts on broader markets. Overall, DeFi lending with proper governance is operationally viable, but it also faces constraints related to capital efficiency, liquidation risk, and systemic fragility within the crypto ecosystem.

Suggested Citation

  • Jonathan Chiu & Furkan Danisman, 2026. "DeFi Lending: Returns, Leverage, and Liquidation Risk," Staff Analytical Papers 2026-13, Bank of Canada.
    • Handle: RePEc:bca:bocsap:26-13
    DOI: 10.34989/sap-2026-13
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    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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