Blockchain Based Decentralized Lending Protocols: A Return Analysis Between S&P 500 and DeFi Assets

Abstract

This article aims to explore the potential financial benefits and challenges of decentralized finance (DeFi) in the banking sector. DeFi is a revolutionary approach to financial services that leverages blockchain technology and smart contracts to operate on a decentralized platform. The lending and borrowing process in DeFi is based on the exchange of cryptocurrencies with fixed or variable interest rates, making it more efficient and cost-effective by eliminating intermediaries. This article presents an empirical study that uses a comprehensive analysis of the relationship between the returns of S&P 500 and DeFi assets, including MKR, AAVE, and COMP. The study employs a framework that explains the lending protocols in decentralized finance and compares centralized finance with decentralized finance. The study utilizes an EGARCH model to estimate the volatility of the assets and examine the presence of asymmetry and leverage effects. The results of the analysis show a positive relationship between S&P 500 and MKR, as well as a positive correlation between S&P 500 and COMP, while AAVE does not sign a significant relationship in the mean equation. The EGARCH variance equation results indicate a positive effect of AAVE and a negative effect of COMP on the volatility of S&P 500 returns, with the leverage effect for S&P 500 and COMP. The findings suggest that DeFi has the potential to transform the financial industry and bring about a more inclusive and equitable financial system for all. The article contributes to the limited literature on the subject, offering a complete return analysis of S&P 500 and DeFi assets to provide a better understanding to investors seeking alternative investment options.