On-chain Cash: The Effect of Stablecoin Holdings on Protocol Valuations

Abstract

Decentralized finance (DeFi) entities represent collections of smart contracts (i.e. code) that execute autonomously. Many of these protocols comprise two separate sets of smart contracts. On the operational side a protocol, say a DEX, consists of an automated market maker (AMM), which implements liquidity pools and fee mechanisms. On the governance side, protocols use decentralized DAOs to support operations with an institutional structure that includes a collective governance mechanism. A central function of smart contracts at both layers is to lock funds (i.e. crypto assets) in the ecosystem. User funds that are deposited into liquidity pools are commonly measured through the TVL metric. It captures the amount of self-custodial funds, that is, user controlled assets in a protocol. Yet, several protocols maintain a separate set of DAO-controlled funds at the governance layer, to finance development. This study takes a corporate finance perspective in classifying on-chain token holdings, exploring the relationship between cash holdings and protocol valuations in a panel vector autoregression (VAR) . The study contributes insights to the blockchain and corporate finance literature.