Owing to the meteoric rise in the usage of cryptocurrencies, there has been a widespread adaptation of traditional financial applications such as lending, borrowing, margin trading, and more, to the cryptocurrency realm. In some cases, the inherently transparent and unregulated nature of cryptocurrencies leads to attacks on users of these applications. One such attack is frontrunning, where a malicious entity leverages the knowledge of currently unprocessed financial transactions submitted by users and attempts to get its own transaction(s) executed ahead of the unprocessed ones. The consequences of this can be financial loss, inaccurate transactions, and even exposure to more attacks. We propose FIRST, a framework that prevents frontrunning attacks, and is built using cryptographic protocols including verifiable delay functions and aggregate signatures. In our design, we have a federated setup for generating the public parameters of the VDF, thus removing the need for a single trusted setup. We formally analyze FIRST, prove its security using the Universal Composability framework and experimentally demonstrate the effectiveness of FIRST.
Jan Arvid Berg, Robin Fritsch, Lioba Heimbach, Roger Wattenhofer
Decentralized exchanges are revolutionizing finance. With their ever-growing increase in popularity, a natural question that begs to be asked is: how efficient are these new markets? We find that nearly 30% of analyzed trades are executed at an unfavorable rate. Additionally, we observe that, especially during the DeFi summer in 2020, price inaccuracies across the market plagued DEXes. Uniswap and SushiSwap, however, quickly adapt to their increased volumes. We see an increase in market efficiency with time during the observation period. Nonetheless, the DEXes still struggle to track the reference market when cryptocurrency prices are highly volatile. During such periods of high volatility, we observe the market becoming less efficient - manifested by an increased prevalence in cyclic arbitrage opportunities.
Hans Gersbach, Akaki Mamageishvili, Manvir Schneider
On several proof-of-stake blockchains, agents engaged in validating transactions can open a pool to which others can delegate their stake in order to earn higher returns. We develop a model of staking pool formation in the presence of malicious agents and establish existence and uniqueness of equilibria. We then identify potential and risk of staking pools. First, allowing for staking pools lowers blockchain security. Yet, honest stake holders obtain higher returns. Second, by choosing welfare optimal distribution rewards, staking pools prevent that malicious agents receive large rewards. Third, when pool owners can freely distribute the returns from validation to delegators, staking pools disrupt blockchain operations, since malicious agents attract most delegators by offering generous returns.
Financial technology (Fintech) is disrupting finance at a rapid pace, forcing a rethink on legacy financial regulation. In particular, the question of the regulatory treatment of crypto-assets and blockchain and distributed ledger technologies (DLTs) has been a major focus of regulators and market participants since the launch of Bitcoin in 2009, and further still since the crypto bubble of 2018.1 Yet, a more general question is even more important: How should innovation and the use of only partially understood technology be regulated? In Europe, this was for a long time up in the air. Since the European Commission’s Fintech Action Plan of 2018 signalled a determination to make beneficial use of technical innovation,2 the Commission has taken a broad approach by adopting on 24 September 2020 a new Digital Finance Package.3 That package comprised the new Digital Finance Strategy (DFS 2020)4 combined with a renewed Retail Payments Strategy,5 in an effort to ‘boost Europe’s competitiveness and innovation in the financial sector, paving the way for Europe to become a global standard-setter’.6 The Commission ‘aims to boost responsible innovation in the EU’s financial sector, especially for highly innovative digital start-ups, while mitigating any potential risks related to investor protection, money laundering and cyber-crime’.7
Caballero Guillermo, Johansson Erica, Thomas Keijser, Vermaas Maria
Abstract This chapter analyzes the occurrence of an imbalance when more securities are credited to the securities accounts of the account holder than its intermediary actually holds. It reviews different reasons that an imbalance can occur that can have a disruptive effect on the intermediated holding system, such as an administrative error or even fraud. It also discusses the requirement that intermediaries should hold sufficient securities to cover the claims of their account holders and examines the allocation of securities to account holders, notably by way of segregation. The chapter highlights allocation as a crucial factor when determining how shortfalls should be distributed in insolvency. It considers the possible impact of new technology, such as the distributed ledger technology (DLT).
With the belief that Distributed Ledger Technology (DLT) holds the promise of bringing greater efficiency, inclusion and innovation to the financial system, the Bank of Thailand (BOT) began research and development of a proof-of-concept central bank digital currency (CBDC) utilising DLT for wholesale domestic and cross-border funds transfers, beginning with Project Inthanon in 2018. A proof-of-concept corporate CBDC was also subsequently developed, and the exploration of a retail CBDC for the general public is currently under way. In this paper, we discuss the important findings and considerations of each CBDC project. We found that DLT can increase efficiency in both domestic payment systems as well as cross-border transactions by enabling direct transfers between parties and providing enhanced programmability through the use of smart contracts. Several technical shortcomings still exist and will need to be reevaluated. Furthermore, studies on governance structure, regulatory issues and implications of CBDC for monetary policy, financial stability and the future financial landscape must be carried out before proceeding to develop production-ready systems and networks.
This paper reviews recent studies on banking in Korea by classifying a substantial body of literature into three categories – the role of banks in the real economy, the efficiency and performance of the banking industry, and regulatory and policy issues. This paper differs from previous survey literature in that it offers a comprehensive systematic literature review of banking studies in Korea in a decade on from the global financial crisis and presents statistics of research articles on various topics in banking published in major economics and finance journals. We find the rising trend of banking research across all subjects, and in particular, dramatic increases around the global financial crisis. This paper also reveals a lack of studies on several topics such as distributed ledger technologies and central bank digital currency, recommending future research on these topics.
Abstract This chapter uses mobile payments and distributed ledger business models and technologies as case studies to demonstrate how operational problems in the payments system can trigger and transmit financial distress. It also examines proposals for central bank digital currencies (CBDCs) and proposals to use distributed ledger technology for post-trade processing, concluding that while there are strong use cases for these types of fintech innovations, they are not without financial stability risks. This chapter therefore stresses the need for a new type of “macro-operational” regulation that responds to the potential systemic interactions of operational problems. Finally, this chapter considers the risks associated with increased reliance on a small group of third-party technology vendors (particularly cloud computing vendors).
Decentralized Finance (DeFi) services are moving traditional financial operations to the Internet of Value (IOV) by exploiting smart contracts, distributed ledgers, and clever heterogeneous transactions among different protocols. The exponential increase of the Total Value Locked (TVL) in DeFi foreshadows a bright future for automated money transfers in a plethora of services. In this short survey paper, we describe the business model for different DeFi domains - namely, Protocols for Loanable Funds (PLFs), Decentralized Exchanges (DEXs), and Yield Aggregators. We claim that the current state of the literature is still unclear how to value thousands of different competitors (tokens) in DeFi. With this work, we abstract the general business model for different DeFi domains and compare them. Finally, we provide open research challenges that will involve heterogeneous domains such as economics, finance, and computer science.
The euro is for many reasons a remarkable legal tender. Even though formally introduced only in 1999, it soon became the second most important currency after the US Dollar in the international monetary system. The 20th anniversary of the euro offers an ideal occasion to reflect on decisive factors underlying its successes and failures. Employing a combined approach that links aspired reforms of the Economic and Monetary Union with novel topics arising from financial technology, this article derives important lessons for the next generation of virtual currencies and furthermore proposes a set of guiding principles for modern regulation and supervision. As a result, the study contributes to safeguarding the financial order in a global and dynamic environment. EU law, euro, virtual currency, crypto-asset, digital currency, legal tender, money, payment system, Economic and Monetary Union (EMU), European Central Bank (ECB), regulation and supervision, international standards, financial crisis, risk management, financial technology (fintech), Distributed Ledger Technology (DLT)
Rui Ma, Ben R. Marshall, Nhut H. Nguyen, Nuttawat Visaltanachoti
Bitcoin is becoming a popular financial asset and means of transacting. However, little is known about an important aspect of the bitcoin market: its liquidity. We consider whether various dimensions of liquidity evident in other asset classes are present in bitcoin spot and futures liquidity. We find variations in spot liquidity across bitcoin exchanges and a strong commonality in bitcoin spot and futures market liquidity. The pricing of spot and futures bitcoin is relatively inefficient, and liquidity plays an important role. Deterioration in liquidity also contributes to bitcoin crash risk and large return declines. JEL Classification: G11, G23
The banking sector faces significant challenges in managing operational and transactional risks, which can result in financial losses, inefficiencies, and reputational damage. With its unique attributes of decentralization, transparency, immutability, and advanced cryptographic security, blockchain technology offers a transformative solution to these challenges. This paper explores the role of blockchain in mitigating operational risks, such as human error, fraud, and system failures, through automation, enhanced auditability, and process accountability. It also examines how distributed ledger technology addresses transactional risks by improving payment security, minimizing settlement delays, and enhancing data integrity. The paper highlights the key benefits of blockchain adoption for risk management and provides recommendations for its effective implementation, including the need for regulatory adaptation, technological investment, and cross-sector collaboration. This analysis underscores the potential of blockchain to revolutionize banking operations and strengthen risk management frameworks in the financial sector.
Abstract Decentralization of finance is usually regarded as a revolution in just the field of finance. However, thanks to chain structures (e.g. blockchain) ranging from supply chain management to enterprise resource management systems, decentralization gradually reforms all aspects of global business simultaneously. Cryptocurrency markets and decentralization of network structures may be considered as two independent chaotic processes by an uninformed observer; however, almost every step of this transformation process can be associated with a certain innovative motivation which was designed for a specific purpose. In this chapter, the implications of financial decentralization movements have been discussed with the assumption that the cryptocurrency market movements and relevant infrastructure improvements may be regarded as the end result of a chain of events which may be influenced by a number of decision-makers. The system components affecting the adoption process have been divided into four categories. Three potential scenarios have been presented for each category with an emphasis on their potential effects on the global business environment. Using intuitive logic, a pathway has been speculated for the adoption process for each component of decentralized finance. Topics discussed in this context should be regarded as pure speculation and should not be perceived as investment advices in any shape or form.
Bit coin might be known as the first crypto currency, the truth holds that it has been the first successful attempt towards the path of decentralized world that paved the way for vast technological advances bring forth thousands of coins in the new online world.Based on respective block chains and operated as a peer-to-peer network, its security is guaranteed by cryptographic algorithms instead of the sovereigns of the respective countries and has the potential to become a major means of payment for ecommerce, trading and as it forays into the art world who knows what the future of block chain holds.Instead of serving one country or some countries, block chain serves the entire world.
Private cryptocurrencies allow for payments without the need for a financial institution. These institutions, the central bank and retail banks, may thus observe a decline in the demand for their payments systems, i.e. cash and deposits. Using the monetary search model of Lagos and Wright (2005), we show that the central bank is able to tilt the playing field until it wins. By introducing an interest-bearing central bank digital currency (CBDC), the central bank is able to provide a payment system which is superior to cryptocurrencies. Miners cannot match the CBDC rate and go bankrupt. Retail banks, on the other hand, face lower profits but survive in the equilibrium. In addition, it can be welfare-improving to kick out cryptocurrencies by an interest-bearing CBDC.
In this paper, we evaluate the economic value of a blockchain application. In the context of asset-backed securities (ABS) issuance in China, where some ABS are issued with blockchain technology and others are not, we find that the use of blockchain significantly reduces the coupon yield at issuance. Compared with other ABS, those issued using blockchain technology experience a decrease of 31.4 basis points in the yield spread, which corresponds to a relative decrease of 13%. We further document that the effect of blockchain is more pronounced for ABS deals rated by less reputable credit rating agencies and agencies that rely more on issuers for their rating business, for revolving ABS, and for ABS with a larger number of underlying assets. We also find that the use of blockchain can reduce the level of retained interest and number of credit enhancement mechanisms. This paper contributes to the literature by providing a small-sample analysis of the economic value of a blockchain application in financial markets. This paper was accepted by Brian Bushee, accounting. Funding: X. Chen and Q. Cheng acknowledge funding provided by the Lee Kong Chian Professorship at Singapore Management University. This work was supported by Singapore Ministry of Education [Grant MOE-T2EP40120-0005]. Supplemental Material: Data are available at https://doi.org/10.1287/mnsc.2023.4671 .