Options are fundamental to blockchain-based financial services, offering essential tools for risk management and price speculation, which enhance liquidity, flexibility, and market efficiency in decentralized finance (DeFi). Despite the growing interest in options for blockchain-resident assets, such as cryptocurrencies, current option mechanisms face significant challenges, including a high reliance on trusted third parties, limited asset support, high trading delays, and the requirement for option holders to provide upfront collateral. In this paper, we present a protocol that addresses the aforementioned issues. Our protocol is the first to eliminate the need for holders to post collateral when establishing options in trustless service environments (i.e. without a cross-chain bridge), which is achieved by introducing a guarantee from the option writer. Its universality allows for cross-chain options involving nearly \textit{any} assets on \textit{any} two different blockchains, provided the chains' programming languages can enforce and execute the necessary contract logic. Another key innovation is reducing option position transfer latency, which uses Double-Authentication-Preventing Signatures (DAPS). Our evaluation demonstrates that the proposed scheme reduces option transfer latency to less than half of that in existing methods. Rigorous security analysis proves that our protocol achieves secure option trading, even when facing adversarial behaviors.
Maria Grith, Caio Almeida, Ratmir Miftachov, Zijin Wang
We analyze the first and second moment risk premia in the Bitcoin market based on options and realized returns and contrast them to the premia embedded in the main US stock index market. First, Bitcoin is much more volatile and has a higher variance risk premium than the S&P 500. By decomposing the return premium into different regions of the return state space, we find that while most of the S&P 500 equity premium comes from mildly negative returns, the corresponding negative Bitcoin returns (between three and one standard deviations) account for only one-third of the total Bitcoin premium (BP). Further, applying a novel clustering algorithm to a collection of estimated Bitcoin option-implied risk-neutral densities, we find that risk premia vary over time as a function of two distinct market volatility regimes. The low-volatility regime implies a relatively high share of BP attributable to positive returns and a high Bitcoin Variance Risk Premium (BVRP). In high-volatility states, the BP attributable to positive and negative returns is more balanced, and the BVRP is lower. These results suggest Bitcoin investors are more concerned about variance and upside risk in a low-volatility regime.
Decentralized Finance (DeFi) has emerged as a transformative force in the financial sector, offering peer-to-peer financial services without traditional intermediaries such as banks. By utilizing blockchain technology and smart contracts, DeFi enables greater accessibility, transparency, and efficiency in financial transactions. However, the rapid expansion of DeFi poses significant challenges to global financial stability. This literature review explores the impact of DeFi on systemic risks, regulatory frameworks, and the traditional banking sector. While DeFi offers opportunities for financial inclusion and innovation, it also introduces new risks related to cybersecurity, liquidity, and market volatility. The absence of standardized regulations across jurisdictions exacerbates these risks, creating vulnerabilities in the global financial system. Furthermore, the interconnection between DeFi markets and traditional financial institutions increases the potential for spillover effects during periods of financial stress. This paper highlights the need for a balanced regulatory approach that fosters innovation while safeguarding financial stability. As DeFi continues to evolve, understanding its influence on global financial stability becomes increasingly important for policymakers, regulators, and financial institutions.
The article examines the essence of electronic money as an economic and legal phenomenon. The relevance of the introduction of innovative technologies in the financial development of modern society, which affect aspects of human life, has been determined. Blockchain technology is highlighted as one of the components of key innovations in the field of digital money. The impact of blockchain on the country’s payment system is substantiated. Blockchain functions are revealed, which open new horizons for the applications of technologies in various fields, making the world more efficient, safer and decentralized. Advantages and disadvantages of electronic money are defined and analyzed. The need to implement measures that would contribute to the mass spread of electronic money in Ukraine is substantiated. The prospects for the economy, which blockchain opens up for the development of decentralized business models, for changing the sphere of finance, are analyzed.Therefore, digital technologies are becoming a necessary cjmponent for the development of the modern economy and financial system. However, their implementation must take into account risks and ensure a high level of security and stability of the financial system. For example, the application of blockchain technologies can significantly simplify and ensure the security of financial transactions. It is also worth exploring the possibilities of using artificial intelligence and data analytics to improve financial decision-making. It is important to actively research and develop new technologies and approaches to ensure the safety and stability of the financial system in this new digital world.
Xinshu Dong, Orfeas Stefanos Thyfronitis Litos, Ertem Nusret Tas, David Tse · 7 authors
The idea of security sharing goes back to Nakamoto's introduction of merge mining, a technique that enables Bitcoin miners to reuse their hash power to bootstrap and secure other Proof-of-Work (PoW) blockchains. However, with the rise of Proof-of-Stake (PoS) chains, there is a need for new methods of Bitcoin security sharing. We introduce Bitcoin staking, a protocol that allows Bitcoin holders to trustlessly use their idle asset to secure a PoS chain. The key challenge is to enable automatic slashing of bitcoins on the Bitcoin chain upon safety violations on the PoS chain. We achieve this using double-authentication-preventing signatures, finality gadgets and bi-directional timestamping between Bitcoin and the PoS chain. Our design is entirely modular and can be integrated with any PoS chain. A version of this protocol was deployed to secure the Babylon mainnet in April 2025 and currently has over 58,000 bitcoins staked (about 4 billion USD at current prices) while paying only 0.05% APR reward to the stakers. This is 2 orders of magnitude cheaper security cost than in PoS chains secured by their native token.
Abstract. The purpose of a consensus protocol is to keep a distributed network of nodes “in sync,” even in the presence of an unpredictable communication network and adversarial behavior by some of the participating nodes. In the permissionless setting relevant to modern blockchain protocols, these nodes may be operated by a large number of unknown players, with each player free to use multiple identifiers and to start or stop running the protocol at any time. Establishing that a permissionless consensus protocol is “secure” thus requires both a distributed computing argument (that the protocol guarantees consistency and liveness unless the fraction of adversarial participation is sufficiently large) and an economic argument (that carrying out an attack would be prohibitively expensive for a potential attacker). There is a mature toolbox for assembling arguments of the former type; the goal of this paper is to lay the foundations for arguments of the latter type. For example, the Ethereum protocol is oft-claimed to be “more economically secure” after “the merge,” meaning in its current proof-of-stake incarnation relative to the (proof-of-work) original. What, formally, does this assertion mean? Is it true? Could there be alternative protocols that are “still more economically secure” than Ethereum? How do the answers depend on the assumptions imposed on, for example, the reliability of message delivery or the active participation of non-malicious players? An ideal permissionless consensus protocol would, in addition to satisfying standard consistency and liveness guarantees, render consistency violations prohibitively expensive for the attacker without collateral damage to honest participants—for example, by programatically confiscating an attacker’s resources without reducing the value of honest participants’ resources, as is the intention for slashing in a proof-of-stake protocol. We make this idea precise with our notion of the EAAC (expensive to attack in the absence of collapse) property and prove the following results: (1) In the synchronous and dynamically available setting (in which the communication network is reliable but nonmalicious players may be periodically inactive), with an adversary that controls at least one-half of the overall resources, no protocol can be EAAC. In particular, this result rules out EAAC for all typical longest-chain protocols (be they proof-of-work or proof-of-stake). (2) In the partially synchronous and quasi-permissionless setting (in which resource-controlling non-malicious players are always active but the communication network may suffer periods of unreliability), with an adversary that controls at least one-third of the overall resources, no protocol can be EAAC. In particular, slashing in a proof-of-stake protocol cannot achieve its intended purpose if message delays cannot be bounded a priori. (3) In the synchronous and quasi-permissionless setting, there is a proof-of-stake protocol with slashing that, provided the adversary controls less than two-thirds of the overall stake, satisfies the EAAC property. Thus, while only “classical security” is possible in the dynamically available or partially synchronous settings, proof-of-stake protocols with slashing can obtain additional “economic security” in the quasi-permissionless and synchronous settings. All three results are optimal with respect to the size of the adversary. With respect to Ethereum, our work formalizes the potential security benefits of proof-of-stake sybil-resistance coupled with slashing and the common belief that the merge has increased Ethereum’s economic security. Our work also provides mathematical justifications for several key design decisions behind the post-merge Ethereum protocol, ranging from long cooldown periods for unstaking to economic penalties for inactivity.
Exploring complex adaptive financial trading environments through multi-agent based simulation methods presents an innovative approach within the realm of quantitative finance. Despite the dominance of multi-agent reinforcement learning approaches in financial markets with observable data, there exists a set of systematically significant financial markets that pose challenges due to their partial or obscured data availability. We, therefore, devise a multi-agent simulation approach employing small-scale meta-heuristic methods. This approach aims to represent the opaque bilateral market for Australian government bond trading, capturing the bilateral nature of bank-to-bank trading, also referred to as "over-the-counter" (OTC) trading, and commonly occurring between "market makers". The uniqueness of the bilateral market, characterized by negotiated transactions and a limited number of agents, yields valuable insights for agent-based modelling and quantitative finance. The inherent rigidity of this market structure, which is at odds with the global proliferation of multilateral platforms and the decentralization of finance, underscores the unique insights offered by our agent-based model. We explore the implications of market rigidity on market structure and consider the element of stability, in market design. This extends the ongoing discourse on complex financial trading environments, providing an enhanced understanding of their dynamics and implications.
A tool to improve the effectiveness and the efficiency of public spending is proposed here. In the 19th century banknotes had a serial number. However, in modern days the use of digital transactions that do not use physical currency has opened the possibility to digitally track almost each cent of the economy. In this article a serial number or tracking number for each cent, pence or any other monetary unit of the economy is proposed. Then, almost all cents can be tracked by recording the transactions in a public distributed ledger, rather than recording the amount of the transaction, the information recorded in the block of the transaction is the actual serial number or tracking number for each cent that changes ownership. In order to keep the privacy of the transaction, only generic identification of private companies and individuals are recorded along with generic information about the concept of transaction, the region and the date/time. A secondary public distributed ledger whose blocks are identified by a hash reference that is recorded in the bank statement available to the payer and the payee allows for checking the accuracy of the first public distributed ledger by comparing the transactions made in one day, one region and one type of concept. However, the transactions made or received by the government are recorded with a much higher level of detail in the first ledger and a higher level of disclosure in the second ledger. The result is a tool that is able to accurately track public spending, to keep privacy of individuals and companies and to make statistical analysis and experiments or real tests in the economy of a country. This tool has the potential to assist public policymakers in demonstrating the societal benefits resulting from their policies, thereby enabling more informed decision-making for future policy endeavours.
We consider Geometric Mean Market Makers (G3Ms) – a special type of Decentralized Exchange – with two types of traders: liquidity takers and arbitrageurs. Liquidity takers use G3Ms to swap tokens and to speculate, while arbitrageurs exploit arbitrage opportunities arising from misalignments between the G3M's price and the external market price. We show that in continuous time, a G3M charging proportional transaction fees offers exchange rates that are of finite variation, and that the opportunity cost of providing liquidity relative to rebalancing a self-financing constant-weights portfolio is, in fact, a non-negative gain. Moreover, we demonstrate that Impermanent Loss can be super-hedged in continuous time by a model-free rebalancing strategy. We conclude with a numerical analysis discussing the approximative nature of our continuous-time results for trading in discrete time.
Abstract This study investigated the extent of currency competition within the cryptocurrency market through the Hayek’s concept of the denationalization of money. Hayek’s original analysis primarily centered on competition revolving around the medium of the exchange function. This study posited that cryptocurrencies compete across diverse monetary functions, particularly concerning their roles as speculative stores of value and exchange media. This assertion provided insight into the distinction between Hayek’s envisaged private currencies and the cryptocurrency paradigm. Utilizing an extensive dataset encompassing 101 cryptocurrencies spanning from 2016 to 2022, an empirical exploration was conducted to scrutinize the progression and intensity of competition within the broader cryptocurrency market and its submarkets. These findings reveal a robust competition among unpegged cryptocurrencies, predominantly contending for speculative investment purposes. Similarly, there is pronounced competition among stablecoins as stable stores of value. In contrast, competition is much less pronounced concerning the medium of the exchange function, potentially entailing network effects and the emergence of monopolistic tendencies within this specific submarket.
Staking has emerged as a crucial concept following Ethereum’s transition to Proof-of-Stake consensus. The introduction of Liquid Staking Derivatives (LSDs) has effectively addressed the illiquidity issue associated with solo staking, gaining significant market attention. This paper analyzes the LSD market dynamics from the perspectives of both liquidity takers (LTs) and liquidity providers (LPs). We first quantify the price discrepancy between the LSD primary and secondary markets. Then we investigate and empirically measure how LTs can leverage such discrepancy to exploit arbitrage opportunities, unveiling the potential barriers to LSD arbitrages. In addition, we evaluate the financial profit and losses experienced by LPs who supply LSDs for liquidity provision. Our results show that 66% of LSD liquidity positions generate returns lower than those from simply holding the corresponding LSDs.
We study the temporal evolution of the holding-time distribution of bitcoins and find that the average distribution of holding-time is a heavy-tailed power law extending from one day to over at least $200$ weeks with an exponent approximately equal to $0.9$, indicating very long memory effects. We also report significant sample-to-sample variations of the distribution of holding times, which can be best characterized as multiscaling, with power-law exponents varying between $0.3$ and $2.5$ depending on bitcoin price regimes. We document significant differences between the distributions of book-to-market and of realized returns, showing that traders obtain far from optimal performance. We also report strong direct qualitative and quantitative evidence of the disposition effect in the Bitcoin Blockchain data. Defining age-dependent transaction flows as the fraction of bitcoins that are traded at a given time and that were born (last traded) at some specific earlier time, we document that the time-averaged transaction flow fraction has a power law dependence as a function of age, with an exponent close to $-1.5$, a value compatible with priority queuing theory. We document the existence of multifractality on the measure defined as the normalized number of bitcoins exchanged at a given time.
The Proof of Efficient Liquidity (PoEL) protocol, designed for specialised Proof of Stake (PoS) consensus-based blockchains that incorporate intrinsic DeFi applications, aims to support sustainable liquidity bootstrapping and network security. This concept seeks to efficiently utilise budgeted staking rewards to attract and sustain liquidity through a risk-structuring engine and incentive allocation strategy, both of which are designed to maximise capital efficiency. The proposed protocol serves the dual objective of: (i) capital creation by attracting risk capital efficiently and maximising its operational utility for intrinsic DeFi applications, thereby asserting sustainability; and (ii) enhancing the adopting blockchain network's economic security by augmenting their staking (PoS) mechanism with a harmonious layer seeking to attract a diversity of digital assets. Finally, the protocol's conceptual framework, as detailed in the appendix, is extended to encompass service fee credits. This extension capitalises on the network's auxiliary services to disperse incentives and attract liquidity, ensuring the network achieves and maintains the critical usage threshold essential for its sustained operational viability and progressive growth.
The prevalence of maximal extractable value (MEV) in the Ethereum ecosystem has led to a characterization of the latter as a dark forest. Studies of MEV have thus far largely been restricted to purely on-chain MEV, i.e., sandwich attacks, cyclic arbitrage, and liquidations. In this work, we shed light on the prevalence of non-atomic arbitrage on decentralized exchanges (DEXes) on the Ethereum blockchain. Importantly, non-atomic arbitrage exploits price differences between DEXes on the Ethereum blockchain as well as exchanges outside the Ethereum blockchain (i.e., centralized exchanges or DEXes on other blockchains). Thus, non-atomic arbitrage is a type of MEV that involves actions on and off the Ethereum blockchain. In our study of non-atomic arbitrage, we uncover that more than a fourth of the volume on Ethereum's biggest five DEXes from the merge until 31 October 2023 can likely be attributed to this type of MEV. We further highlight that only eleven searchers are responsible for more than 80% of the identified non-atomic arbitrage volume sitting at a staggering $132 billion and draw a connection between the centralization of the block construction market and non-atomic arbitrage. Finally, we discuss the security implications of these high-value transactions that account for more than 10% of Ethereum's total block value and outline possible mitigations.
Depositing and borrowing in a currency other than the local currency is a well- documented phenomenon. The associated exchange rate and monetary risks, pivotal during the Asian Financial Crisis of 1997, prompted an academic discourse. Financial dollarization literature explains why individuals and corporations domiciled in emerg- ing markets deposit and borrow in hard currencies, mainly in U.S. dollars. This thesis proposes a model for cryptocurrency lending and assesses model predictions with a data set containing more than one million Ethereum transactions. The computational modelling and statistical analysis show that the main theoretical explanations provided by financial dollarization literature may not be directly transferable to cryptocurrencies. The results suggest that the popularity of depositing and borrowing in cryptocurrencies must be largely motivated by other factors.
Charles Bertucci, Louis Bertucci, Mathis Gontier Delaunay, Olivier Guéant · 5 authors
ABSTRACT Contrasting sharply with traditional money, bond, and bond futures markets, where interest rates emerge organically from participant interactions, DeFi lending platforms employ rule‐based interest rates that are algorithmically set. Thus, the selection of an effective interest rate model (IRM) is paramount for the success of a lending protocol. This paper investigates the modeling of agents' behaviors on lending platforms and proposes a theoretical framework for formulating optimal IRMs. We show that, under perfect information, an optimal control model with a state constraint generates an optimal interest rate policy that has a shape similar to that of popular markets. Furthermore, we formally analyze interest rate policies based on PID controllers, which work efficiently based on fewer assumptions. Using public data of popular markets on the Ethereum blockchain, we analyze agents' behavior, build a realistic simulation environment, and highlight the main tradeoffs in the design of interest rates for decentralized lending platforms.
This paper considers introducing asymmetric privacy in the design of central bank digital currencies (CBDC) and digital currencies more generally to preserve the privacy of money spent while keeping the benefits of digital records for money received. It is shown that this feature would help minimize real distortions between consumers, firms, and financiers while enabling tax optimization and better access to external financing. Protecting the privacy of consumers is desirable from a welfare and efficiency standpoint as long as there exist noticeable privacy concerns. Implementing asymmetric privacy is technologically feasible, using, for instance, zero-knowledge proofs or other privacy tools. This paper has been accepted by Lin William Cong for the Virtual Special Issue on Digital Finance. Supplemental Material: The online appendix is available at https://doi.org/10.1287/mnsc.2024.06830 .