Facts and Fantasies About DeFi: Lending, DEX, and Derivatives

Abstract

ABSTRACT We explore the risk‐return tradeoff of Decentralized Finance (DeFi). We construct three novel indices for different asset classes: Lending, Decentralized Exchanges, and Derivatives. Motivated by the cryptocurrency pricing framework of Liu and Tsyvinski, we investigate how DeFi assets comove with financial primitives. We document limited correlation with traditional equities, currencies, interest rates, and commodities. We further examine several DeFi‐specific factors. Bitcoin and Ethereum returns show no significant association with subsequent DeFi returns, highlighting a decoupling between base‐layer assets and application‐layer protocols. Meanwhile, we find some in‐sample associations with DeFi‐specific factors such as momentum, investor attention, and performance of centralized platforms. A novel book‐to‐market ratio constructed using Total Value Locked and market capitalization does not display a systematic relationship with returns. Finally, we find only limited and sector‐specific associations with traditional equity industries.