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Systemic fragility in decentralised markets

Author

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  • Alfred Lehar
  • Christine A Parlour

Abstract

We analyze a unique data set of collateral liquidations on two Decentralized Finance lending platforms – Compound and Aave. Such liquidations require arbitrageurs to repay the loan in return for the discounted collateral. Using Blockchain transaction data, we observe if arbitrageurs liquidate positions out of their own inventory or obtain "flash loans." To repay flash loans, arbitrageurs immediately sell the collateral asset. We document the high frequency price impact of such liquidity trades on nine different decentralized exchanges. Consistent with large block trades in equity markets there is a temporary and permanent price impact of collateral asset sales in DeFi. We document the effect of these trades on return distributions. Our work highlights the systemic fragility of decentralized markets.

Suggested Citation

  • Alfred Lehar & Christine A Parlour, 2022. "Systemic fragility in decentralised markets," BIS Working Papers 1062, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:1062
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    References listed on IDEAS

    as
    1. Holthausen, Robert W. & Leftwich, Richard W. & Mayers, David, 1990. "Large-block transactions, the speed of response, and temporary and permanent stock-price effects," Journal of Financial Economics, Elsevier, vol. 26(1), pages 71-95, July.
    2. Saar, Gideon, 2001. "Price Impact Asymmetry of Block Trades: An Institutional Trading Explanation," The Review of Financial Studies, Society for Financial Studies, vol. 14(4), pages 1153-1181.
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    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. Chemaya, Nir & Cong, Lin William & Joergensen, Emma & Liu, Dingyue & Zhang, Luyao, 2023. "Uniswap Daily Transaction Indices by Network," OSF Preprints ube2z, Center for Open Science.
    3. Schuler, Katrin & Nadler, Matthias & Schär, Fabian, 2023. "Contagion and loss redistribution in crypto asset markets," Economics Letters, Elsevier, vol. 231(C).
    4. Lin William Cong & Ke Tang & Yanxin Wang & Xi Zhao, 2023. "Inclusion and Democratization Through Web3 and DeFi? Initial Evidence from the Ethereum Ecosystem," NBER Working Papers 30949, National Bureau of Economic Research, Inc.
    5. Erdong Chen & Mengzhong Ma & Zixin Nie, 2024. "Perpetual future contracts in centralized and decentralized exchanges: Mechanism and traders’ behavior," Electronic Markets, Springer;IIM University of St. Gallen, vol. 34(1), pages 1-36, December.
    6. Nir Chemaya & Lin William Cong & Emma Jorgensen & Dingyue Liu & Luyao Zhang, 2023. "A Dataset of Uniswap daily transaction indices by network," Papers 2312.02660, arXiv.org, revised Sep 2024.

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    More about this item

    Keywords

    Decentralized lending; blockchain; decentralized finance; system risk;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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