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Grasping De(centralized) Fi(nance) through the Lens of Economic Theory

Author

Listed:
  • Jonathan Chiu

    (Bank of Canada)

  • Thorsten V. Koeppl
  • Charles M. Kahn

Abstract

In this viewpoint article, we provide an analysis of the value proposition of De(centralized) Fi(nance) 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 nancial 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 limiations could improve the value of DeFi.

Suggested Citation

  • Jonathan Chiu & Thorsten V. Koeppl & Charles M. Kahn, 2022. "Grasping De(centralized) Fi(nance) through the Lens of Economic Theory," Working Paper 1489, Economics Department, Queen's University.
  • Handle: RePEc:qed:wpaper:1489
    as

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    File URL: https://www.econ.queensu.ca/sites/econ.queensu.ca/files/wpaper/qed_wp_1489.pdf
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    References listed on IDEAS

    as
    1. 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.
    2. 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.
    3. 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.
    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.
    Full references (including those not matched with items on IDEAS)

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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. 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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    More about this item

    Keywords

    Decentralized Finance; Cryptocurrency; Stablecoins; Collateralized Lending;
    All these keywords.

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services

    NEP fields

    This paper has been announced in the following NEP Reports:

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