Minh Hong Nguyen, Binh Nguyen Thanh, Huy Pham, Thi Thu Tra Pham
Decentralized lending in the DeFi ecosystem mirrors traditional financial intermediation but poses significant risks, particularly funding liquidity risk, due to the volatility and composbility of digital assets, high leverage, and the absence of regulatory protections. This study applies traditional financial intermediation theories to DeFi lending and empirically test which internal factors such as interest rates and user market power, as well as external factors like the USD Index, influence funding liquidity risk in DeFi lending. Analyzing high-frequency blockchain data using the ARDL model and a novel dynamic ARDL simulation from major pools such as Wrapped Bitcoin (WBTC) and Wrapped Ethereum (WETH), the research finds that current algorithmic interest rate models fail to function as effective self-stabilization mechanisms. Additionally, lower deposit concentration in these pools may exacerbate, rather than mitigate, funding liquidity risk.
Automated Market Makers with concentrated liquidity have to date achieved market dominance among competing spot trading AMM models in Decentralized Finance. We shift the prevalent research focus on liquidity providersâ loss metrics, such as Impermanent Loss or Loss-Versus-Rebalancing, to a market neutral strategy. We derive a hedge portfolio which allows for concentrated liquidity provision while maintaining market neutrality. We present an example of the hedge portfolio and highlight the practical restrictions. The hedge portfolio consisting of options and futures requires a significant capital outlay compared to the amount of liquidity provided, but typically earns carry from futures contango.
We analyze a unique chief financial officer (CFO) survey data set to examine capital allocation in firms. Top management is aware of agency and information problems at the divisional level and organizes the budgeting process to counteract managerial opportunism, employing systems of interconnected measures, including layers of approval, divisional budgets, reporting requirements, and compensation schemes. When making funding decisions, top management relies heavily on top-level nonfinancial information, such as the assessment of divisional managersâ abilities. However, substantial parts of the capital budget do not require top management approval as firms trade off the benefits and costs of decentralization, thereby deviating from the traditional paradigm of decentralized project initiation but centralized project approval. Even firms with active internal capital markets tilt capital allocation toward relatively even distributions, reflecting the use of capital allocation as a credible communication device. We also find that within-firm agency problems may result in capital rationing, that is, divisionsâ restricted access to internal capital. CFOs also believe that integrating multiple businesses into an internal capital market results in tangible financial benefits, predominantly lower costs of capital and higher debt capacities. Thus, our findings also support coinsurance arguments suggesting that internal capital markets may improve access to external financing. This paper was accepted by Victoria Ivashina, finance. Funding: This work was supported by the BBBank Karlsruhe, WissenschaftsfĂśrderung der Sparkassen-Finanzgruppe, and Karlsruher Institut fĂźr Technologie (Karlsruhe House of Young Scientists). Publishing fees were supported by the âFunding Programme Open Access Publishingâ of the University of Hohenheim. Supplemental Material: The online appendices and data files are available at https://doi.org/10.1287/mnsc.2021.02755 .
We investigate how exchange default risk and liquidity affect Bitcoin cross-exchange arbitrage opportunities. Analyzing minute-level data from 16 cryptocurrency exchanges (April 2013âApril 2024), we find arbitrage opportunities last longer when higher-risk exchanges have higher prices, as traders are cautious of default risks. There is a strong positive relation between capital flows from high-risk to low-risk exchanges and arbitrage opportunities, showing a preference for safer exchanges. Liquidity accelerates arbitrage by enabling faster execution, but high transaction fees and blockchain congestion slow capital transfers. The paper highlights exchange risk, liquidity, and transaction costs as key factors in Bitcoin market efficiency. ⢠Exchange default risk significantly impacts Bitcoin cross-exchange arbitrage behaviour. ⢠Arbitrage is more persistent when high-risk exchanges have higher prices. ⢠Higher liquidity enhances the effect of net flows on Bitcoin arbitrage opportunities. ⢠Blockchain congestion and fees hinder capital movement, slowing arbitrage execution.
The emergence of cryptocurrency has prompted concerns regarding its potential threat to traditional banking systems. However, on closer examination, cryptocurrency could prove to be a new opportunity for traditional banks to improve their services and respond to the changing face of finance. Cryptocurrencies have had a great following recently, with major financial institutions and government entities recognizing their possible effect on monetary policy, payment systems, and financial innovation. Research suggests that crypto could raise systemic risk to mature markets. Still, this impact, however likely, is not yet profound, and crypto may present opportunities for traditional banks to enhance their operations and offerings. This paper analyzes and tries to identify whether cryptocurrency can become dangerous for the banking industry or, the other way around, the financial institutions can make cryptocurrency less reliable and dangerous
Decentralized Finance (DeFi) has emerged as a transformative force in the financial landscape, challenging traditional systems and offering innovative solutions. As DeFi continues to evolve, it is essential to explore its implications for the future of finance, regulation, technology, and society. This research article outlines a comprehensive future research agenda that encompasses key dimensions of DeFi, including technological advancements, regulatory frameworks, economic impacts, and societal consequences. By identifying critical areas for inquiry, this paper aims to guide scholars, practitioners, and policymakers in navigating the complexities and opportunities presented by DeFi. The findings highlight the need for interdisciplinary collaboration to foster responsible innovation, enhance financial inclusion, and address the challenges that lie ahead.
This research paper explores the dichotomy between Centralized Finance (CeFi) and Decentralized Finance (DeFi) within the context of the Indian Constitution. It critically analyzes the constitutional implications of both systems, particularly focusing on how centralized authorities may misuse their power to curtail freedoms guaranteed under the Constitution. Additionally, the paper investigates how DeFi can support constitutional values such as privacy, freedom of trade, and equality. Finally, it examines how centralized authorities are actively hindering DeFi-based implementations to maintain control over financial systems, thereby compromising democratic principles.
Huned Materwala, Shraddha M. Naik, Ali S. Taha, Tala Abdulrahman Abed ¡ 5 authors
Decentralized Finance (DeFi) leverages blockchain-enabled smart contracts to deliver automated and trustless financial services without the need for intermediaries. However, the public visibility of financial transactions on the blockchain can be exploited, as participants can reorder, insert, or remove transactions to extract value, often at the expense of others. This extracted value is known as the Maximal Extractable Value (MEV). MEV causes financial losses and consensus instability, disrupting the security, efficiency, and decentralization goals of the DeFi ecosystem. Therefore, it is crucial to analyze, detect, and mitigate MEV to safeguard DeFi. Our comprehensive survey offers a holistic view of the MEV landscape in the DeFi ecosystem. We present an in-depth understanding of MEV through a novel taxonomy of MEV transactions supported by real transaction examples. We perform a critical comparative analysis of various MEV detection approaches, evaluating their effectiveness in identifying different transaction types. Furthermore, we assess different categories of MEV mitigation strategies and discuss their limitations. We identify the challenges of current mitigation and detection approaches and discuss potential solutions. This survey provides valuable insights for researchers, developers, stakeholders, and policymakers, helping to curb and democratize MEV for a more secure and efficient DeFi ecosystem.
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.
How will Decentralized Finance transform financial services? Using New Institutional Economics and Dynamic Capabilities Theory, I analyse survey data from 109 experts using non-parametric methods. Experts span traditional finance, DeFi industry, and academia. Four insights emerge: adoption expectations rise from negligible to 43% expecting at least high adoption by 2034; experts expect convergence scenarios over disruption, with traditional finance embracing DeFi most likely; back-office transforms before customer-facing functions; strategic competencies eclipse DeFi-sector specific- and technical skills. This challenges technology-centric adoption models. DeFi represents emerging market entry requiring organizational transformation, not just technological implementation. SEC developments validate predictions. Financial institutions should prioritize developing strategic capabilities over mere technical training.
Abstract Decentralized finance has gained significance in recent years, as have concerns about the financial systemâs stability. Exchange mechanisms, such as those utilized on cryptocurrency platforms, enhance volatility, and transmit risk contagion to other financial actors globally, which may increase financial calamity. We propose a Susceptible-Infected-Recovered model with a time delay to examine the mechanism of risk contagion in the cryptocurrency markets during the last decade. The governance token prices of the main cryptocurrency exchange platforms, as well as their spillover effects, crash risks and indicators of peopleâs attention, are assessed, and the obtained parameters are used in the Susceptible-Infected-Recovered model to replicate the dynamics of risk contagion in the examined crypto markets. Findings suggest high interconnection among crypto markets in short-run and the fear spread among people play an important contribution to financial risks. Under the new decentralized finance paradigm, predictive modeling of the temporal distribution of risk among cryptocurrencies may provide useful insights for policy and financial system stability, as well as for contagion risk.
The ancient Indian festival of Dussehra commemorates the triumph of good over evil, symbolized by Lord Rama's victory over the demon king Ravana. This paper draws an analogy between Centralized Finance (CeFi) and Decentralized Finance (DeFi), using Dussehraâs narrative as a metaphor to illustrate the ongoing battle between centralization and decentralization in the global financial system. CeFi is akin to Ravanaâpower-hungry, self-centered, and opaqueâwhile DeFi represents Rama, who is fair, transparent, and offers equal opportunities to all. This paper examines the core differences between CeFi and DeFi, highlighting how the principles of DeFi are bringing about a paradigm shift in the financial world, much like the symbolic victory of Rama.
Decentralized finance (DeFi) has revolutionized the financial landscape, with protocols like Uniswap offering innovative automated market-making mechanisms. This article explores the development of a backtesting framework specifically tailored for concentrated liquidity market makers (CLMM). The focus is on leveraging the liquidity distribution approximated using a parametric model, to estimate the rewards within liquidity pools. The article details the design, implementation, and insights derived from this novel approach to backtesting within the context of Uniswap V3. The developed backtester was successfully utilized to assess reward levels across several pools using historical data from 2023 (pools Uniswap v3 for pairs of altcoins, stablecoins and USDC/ETH with different fee levels). Moreover, the error in modeling the level of rewards for the period under review for each pool was less than 1%. This demonstrated the effectiveness of the backtester in quantifying liquidity pool rewards and its potential in estimating LP's revenues as part of the pool rewards, as focus of our next research. The backtester serves as a tool to simulate trading strategies and liquidity provision scenarios, providing a quantitative assessment of potential returns for liquidity providers (LP). By incorporating statistical tools to mirror CLMM pool liquidity dynamics, this framework can be further leveraged for strategy enhancement and risk evaluation for LPs operating within decentralized exchanges. ⢠Develop a methodology for backtesting liquidity provision in a CFMM. ⢠Enhance CFMM backtesting by leveraging GPU acceleration for faster computation. ⢠Showcase the practicality of CFMM backtesting using actual Uniswap pool data.
Automated market makers (AMMs) typically rely on arbitrage agents to keep prices in line with a shared reference market such as a large centralized exchange. This paper considers an alternative, even-more-decentralized model where prices must stabilize without a shared reference market.We first consider a model where there is one population of AMMs, and another of arbitrage agents who seek to profit from pairwise price differences between randomly-chosen AMMs. For constant-product AMMs, repeated random pair-wise arbitrage causes the AMMsâ expected prices to converge within any precision Ďľ > 0 in $\Theta \left( {\max \left( {{n^2}\log n,\log \frac{1}{\varepsilon }} \right)} \right.$ interactions, and arbitrage agentsâ profits are proportional to the original price imbalances. Within certain limits, the arbitrage agents can collude to set the final stable price.If, instead, randomly-chosen pairs of AMMs could rebalance their asset pools directly, capturing profits that would have gone to arbitrage agents, then expected AMM prices converge within Ďľ with respective upper and lower bounds of $\Omega \left( {\max \left( {{n^2}\log n,\log \frac{1}{\varepsilon }} \right)} \right.$ and $O\left( {\max \left( {{n^2}\log n,\log \frac{1}{\varepsilon }} \right)} \right.$ interactions. Within certain limits, the AMMs can collude to set the final stable price.
The notion of a âfinancial instrumentâ defines the frontier of traditional financial law, such as the Markets in Financial Instruments Directive (MiFID II), and the more recent crypto regulation, epitomized by the Markets in Crypto-Assets Regulation (MiCAR). The characteristics of a âfinancial instrumentâ cannot be defined statically by way of a checklist. Instead, the definition must be open to future products and developments in the market, which at the moment cannot be foreseen. That is why we suggest a âflexible definitionâ. This definition is composed of typical elements that must not necessarily be present all the time. Rather, the lack of one element may be compensated by the abundance of another. Thanks to the flexible definition, it is possible to achieve both a necessary degree of legal certainty for market participants and sufficient space for supervisory authorities to respond to future developments. The typical elements of financial instruments can be found through a study of EU financial regulation and an analysis of the underlying economic reality. We also draw comparisons to US law that regulates similar problems. Three elements are typically present in financial instruments: (1) they create rights and obligations, (2) they are tradable on markets and (3) they have an investment function. (1) That financial instruments typically create rights and obligations is due to their contractual nature. These rights and obligations must be functionally similar to those arising from products detailed in Annex I Section C of MiFID II. (2) Tradability requires transferability, negotiability, and fungibility. It is best viewed as a spectrum rather than a definitive boundary. (3) The purpose of financial instruments is to generate future financial returns or protect against financial risks. They are not empty shells but serve as legal channels for investment. The investment function must be assessed by taking an ex ante view, based on the endogenous characteristics of a product, the issuerâs intentions and market communications, and the expectations of the public they are likely to generate. The concept of âfinancial instrumentsâ plays a quintessential role in European Union (EU) financial markets law. 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This research investigates the adoption of Dis- tributed Ledger Technology (DLT) in cross-border financial transactions, driven by the increasing need for more efficient, secure, and transparent methods in a globalized financial market. Traditional cross-border transactions often face challenges such as delays, high costs, and security risks, making DLT a promising solution with its ability to provide secure, immutable, and trans- parent transaction records. The study focuses on understanding how trust, security, perceived usefulness, and perceived ease of use influence the adoption of DLT. Conducted with 150 respondents, primarily young adults from Jakarta and Tangerang, the research employed Structural Equation ModelingâPartial Least Squares (SEMâPLS) to test six hypotheses. The results of this study indicate that both Trust and Security have a positive and significant impact on the adoption of Distributed Ledger Technology (DLT) in cross-border financial transactions. Utilizing the Partial Least Squares Structural Equation Modeling (PLS- SEM) method, addressing the growing need for more efficient, secure, and transparent methods in global finance. These findings hold significant practical implications for financial institutions, suggesting that enhancing trust and security in Distributed Ledger Technology (DLT) systems can lead to broader adoption and ultimately improve the efficiency and transparency of cross- border financial transactions. These findings underscore the critical importance of trust and security in promoting DLT adoption in cross-border transactions, suggesting that efforts to enhance these factors will be crucial for broader acceptance of DLT. Future research should explore additional variables, such as regulatory frameworks and cultural factors, that may also affect DLT adoption in different regions.
The rapid growth and increasing prominence of cryptocurrencies in the global financial market have brought new challenges in risk management and asset allocation. The high volatility and interconnectedness of digital assets make understanding risk contagion crucial for investors, portfolio managers, and regulators. Network Science provides a powerful framework for studying these interdependencies by modeling relationships as networks where assets are connected based on various metrics, such as correlations or causality measures. The primary objective of this research is to identify price contagion among cryptocurrencies, using Network Science methodologies to analyze these transmission effects and offering practical insights for risk management and portfolio optimization. The methodology starts with a Network Science approach to model the relationships between cryptocurrencies. Correlation networks are created to visualize the connections between digital assets, indicating where strong relationships and potential contagion effects may occur. To enhance this analysis, Granger causality tests are applied to assess the directionality of these relationships, identifying predictive connections where the performance of one cryptocurrency may impact another. Finally, the Louvain algorithm, a community detection technique within Network Science, is used to cluster cryptocurrencies into groups based on the strength of their interconnections, providing insights into the structural composition of the cryptocurrency market. The network-based approach reveals significant interconnections among cryptocurrencies, with correlation networks indicating clusters of assets that share strong relationships. Granger causality analysis provides evidence of directional risk transmission, suggesting specific paths through which risk may propagate. The Louvain algorithm identifies groups of highly interconnected cryptocurrencies, offering insights into potential diversification strategies and highlighting areas where risk mitigation may be necessary. The results inform investors and portfolio managers on managing risk by identifying groups of cryptocurrencies with strong interdependencies, which may impact v diversification strategies. Additionally, the findings provide valuable insights for regulators aiming to monitor systemic risk in the cryptocurrency market. This study advances the understanding of risk contagion in the cryptocurrency market by integrating Network Science methodologies, including correlation networks, causality analysis, and community detection. It offers a comprehensive view of interdependencies and risk transmission, providing practical guidance for constructing more resilient cryptocurrency portfolios.
Switzerland has emerged as a global leader in the regulation of blockchain technology and digital currencies, attracting numerous blockchain startups and investors to its âCrypto Valley.â This paper provides an in-depth analysis of Switzerlandâs financial regulatory framework, examining its adaptability to blockchain and digital currency innovations. The study highlights the proactive stance of the Swiss Financial Market Supervisory Authority (FINMA) and the enactment of the Blockchain Act, which have created a flexible and forward-thinking legal environment. Furthermore, the paper explores the opportunities afforded by Switzerlandâs regulatory framework, such as legal certainty, privacy protection, and access to European markets. However, it also addresses the challenges that remain, including regulatory arbitrage, scalability issues, and the unique regulatory complexities introduced by decentralized finance (DeFi) and non-fungible tokens (NFTs). The findings suggest that while Switzerland has built a conducive ecosystem for blockchain innovation, it must continue to adapt its regulatory framework to maintain its leadership position in an ever-evolving global landscape.
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.
This paper examines the emergence and impact of Decentralized Finance (DeFi), between 2019 and 2024, as a disruptive agent opposing traditional finance (TradFi). By using blockchain technology to offer decentralized, open, and readily available financial services, the DeFi industry has seen explosive expansion Emphasizing DeFi's competitive advantage over TradFi, this study aims to investigate notable trends, developments, and market drivers in the toolkit. The main conclusions are the fast and significant rise in Total Value Locked (TVL), the clear increase in user adoption, the expansion in the number of transactions and trading volume on decentralized exchanges (DEXs), and the development of creative financial products. DeFi constantly changes the financial scene despite regulatory oversight and market volatility, so posing major problems and opportunities for established financial institutions.
Felix Adebayo Bakare, J. T. Omojola, Augustine Chibuzor Iwuh
Blockchain technology and Decentralized Finance (DeFi) are revolutionizing traditional banking and financial systems by eliminating the need for intermediaries, reducing transaction costs, and fostering more inclusive financial services. Unlike centralized systems that rely on trusted third parties such as banks and payment processors, DeFi operates on decentralized networks powered by blockchain technology. This innovation enables peer-to-peer financial transactions, smart contracts, and automated protocols, allowing for secure and transparent exchanges without the need for intermediaries. The disruption caused by DeFi challenges the conventional financial system by providing users with greater control over their assets and access to a broad range of financial services, including lending, borrowing, trading, and asset management. Through blockchainâs inherent features such as immutability, cryptographic security, and transparency, DeFi systems ensure trust less transactions, reducing the risk of fraud and errors while enhancing privacy. This paper explores the transformative potential of blockchain and DeFi in reshaping the financial landscape, addressing key benefits such as financial inclusion, the democratization of wealth, and more efficient global financial markets. However, the rise of DeFi also brings challenges such as regulatory uncertainty, technological risks, and the need for robust security measures to prevent fraud and ensure user protection. As DeFi continues to evolve, its impact on the future of finance is profound, offering both opportunities and risks that must be carefully navigated.
The BRICS countries intend to create a common payment platform for conducting transactions in digital currencies at the international level â the BRICS Bridge project. The article provides a framework for the development of international CBDC transaction platform that would address the problem of high transaction costs and excessive transaction time for international settlements, which are currently one of the main issues in the traditional economy. Processes and governance structure of the platform are described in the work. Research has shown that CBDC settlements on a distributed ledger technology (DLT)-based platform can reduce information fragmentation and increase information flow for regulatory bodies. However, the use of DLT in international settlements is associated with numerous technical and legal risks, including privacy and data security risks, financial monitoring complications, contradictions between national and international legislation, and bank disintermediation risks. To mitigate these risks, a scheme for conducting international digital transactions based on DLT, combining national and international legislation, and ensuring data privacy and security is proposed.